PRINCIPLES  OF 
DOUBLE-ENTRY    BOOKKEEPING 


PRINCIPLES 


OF 


DOUBLE-ENTRY  BOOKKEEPING 


BY 


CHARLES    M.   VAN    CLEVE 


PUBLISHED    BY   THE    AUTHOR 


PRINTED   AND   FOR    SALE    BY 

THE  JAMES  KEMPSTER  PRINTING  COMPANY 
II7-I2I    LIBERTY   STREET,    NEW    YORK 

1913 


COPYRIGHT,  1913,  BY 
CHARLES  M.  VAN  CLEVE. 


PREFACE 


The  purpose  of  this  treatise,  as  its  title  implies,  is  to 
explain  the  principles  which  underlie  the  art  of  accounting 
by  the  double-entry  method.  It  deals  with  the  interpretation 
rather  than  the  routine  of  bookkeeping,  and  limits  the  dis- 
cussion to  the  three  essential  forms — the  journal  entry,  the 
ledger  account  and  the  balance  sheet./  It  does  not  propose 
any  change  in  the  routine,  but  it  does  propose  a  decided  change 
in  the  interpretation  of  accounts  and  in  the  method  of  report- 
ing results. 

What  I  claim  for  the  book  is  that  it  solves  the  problem 
of  placing  double-entry  bookkeeping  upon  a  rational  basis; 
and  to  the  best  of  my  knowledge  and  belief  it  presents  the 
first  and  only  solution  of  that  problem. 

It  is  one  of  the  strangest  things  in  the  history  of  the  arts 
and  sciences  that  this  great  system  of  accounting,  which,  by 
reason  of  its  compactness  and  convenience,  has  come  into 
almost  universal  use,  should  have  attained  so  high  a  degree 
of  development  on  the  practical  side,  while  on  the  theoretical 
side  it  is  and  always  has  been  in  a  state  of  utter  confusion. 
As  a  rule,  the  study  of  a  useful  art  has  a  certain  value  as 
mental  discipline ;  the  art  of  accounting  is  the  one  exception 
to  the  rule.  Aside  from  the  so-called  occult  sciences,  there 
is  nothing  which  so  tends  to  bewilder  the  mind  and  to  dull  the 
faculty  of  reason  as  the  study  of  double-entry  bookkeeping  in 
the  form  in  which  it  is  customary  to  present  it. 

I  have  read  a  number  of  works  on  the  subject,  including 
some  of  the  most  recent,  but  I  have  never  seen  a  text-book 
which  gave  any  indication  whatever  that  its  author  had  even 
the  remotest  conception  of  the  principles  upon  which  the  art 
is  based;  I  have  never  read  a  text-book  in  which  there  was 

267762 


vi  PEEFACE 

any  logical  argument,  any  consecutive  line  of  reasoning;  in 
short,  I  have  never  read  a  text-book  dealing  with  the  theory 
of  double-entry  bookkeeping  which  was  not  simply  a  more  or 
less  elaborate  attempt  to  beg  the  question.  With  reference 
to  that  statement  one  should  keep  clearly  in  mind  the  dis- 
tinction between  describing  a  process  and  explaining  it.  In 
their  description  of  double-entry  bookkeeping  many  of  the 
text-books  are  very  successful,  and  most  of  them  are  fairly  so  j 
but  in  their  attempts  to  explain  it,  all  of  them,  that  I  have 
ever  read,  are  absolute  failures.  They  answer  the  question 
"how,"  but  so  far  as  my  observation  goes,  there  is  not  one 
of  them  that  answers  the  question  "why." 

What  makes  double-entry  bookkeeping  incomprehensible 
to  the  people  in  general  is  the  fact  that  it  is  the  universal 
custom  in  this  system  of  accounting  to  make  statements  in  a 
form  showing  assets  and  liabilities  equal,  and  losses  and  gains 
unequal — a  form  which  the  common  sense  of  mankind  instinct- 
ively rejects.  In  his  attempts  to  justify  his  practice  the 
accountant  long  ago  devised  the  theory  that  double-entry 
bookkeeping  deals  with  the  assets  and  liabilities,  not  of  the 
proprietor,  but  of  the  business,  and  that  the  assets  and  liabil- 
ities of  the  business  are  always  equal  because  the  proprietor's 
net  capital  is  a  liability  of  the  business  to  the  proprietor. 

The  most  remarkable  thing  about  that  theory  is  that  it 
has  been  accepted  by  the  great  majority  of  accountants  in  spite 
of  the  fact  that  it  is  self-evidently  false.  If  assets  and  liabili- 
ties are  always  equal,  gains  and  losses  are  always  equal;  for 
every  increase  of  asset,  which  is  gain,  there  must  be  a  corre- 
sponding increase  of  liability,  which  is  loss,  and  for  every 
decrease  of  asset,  which  is  loss,  there  must  be  a  corresponding 
decrease  of  liability,  which  is  gain. 

When  the  bookkeeper  professes  to  justify  his  practice  by 
saying  that  his  statement  shows  the  assets  and  liabilities  of 
the  "business,"  he  is  simply  begging  the  question.  What  he 
is  called  upon  to  explain  is  not  merely  the  fact  that  he  shows 


PREFACE  vii 

assets  and  liabilities  equal,  but  the  fact  that  he  shows  assets 
and  liabilities  equal  and  losses  and  gains  unequal;  and  that 
he  never  can  explain,  because  it  is  in  direct  violation  of  the 
axiomatic  proposition  that  if  two  variable  quantities  are  always 
equal,  the  changes  in  those  quantities  must  be  equal.  Among 
all  professedly  rational  pursuits,  the  art  of  accounting,  as  it 
is  taught  and  practiced,  has  the  unique  distinction  of  being 
based  upon  the  denial  of  a  self-evident  truth.  The  doctrine 
of  equal  assets  and  liabilities  is  an  insult  to  the  human  intel- 
lect ;  it  is  a  disgrace  to  the  people  who  teach  it  and  an  outrage 
upon  the  people  who  are  taught. 

But  the  accountant  is  not  a  logician.  He  has  been  trained 
to  believe  that  it  is  a  sufficient  excuse  for  the  form  of  his 
statement  to  say  that  it  shows  the  assets  and  liabilities  of  the 
"business,"  and  he  is  satisfied  with  that.  The  consequence 
is  that  while  it  is  not  difficult  to  explain  this  system  of  account- 
ing, it  is  exceedingly  difficult  to  convince  bookkeepers  that  it 
needs  explanation.  For  that  reason,  before  presenting  the  true 
theory,  it  is  necessary  to  demonstrate  the  utter  absurdity  of 
the  current  method  of  teaching  double-entry  bookkeeping. 
Some  of  the  remarks  which  are  made  on  that  subject  may  be 
displeasing  to  the  reader,  if  he  is  himself  an  accountant ;  but 
I  assure  him  that  they  are  not  made  in  any  spirit  of  fault- 
finding nor  with  any  intent  to  give  offense.  Their  only  object 
is  to  arouse  accountants  to  a  realization  of  the  fact  that  public 
opinion  will  never  accord  to  their  occupation  a  rank  com- 
mensurate with  its  importance,  unless  double-entry  bookkeep- 
ing, both  in  theory  and  in  practice,  is  brought  into  harmony 
with  common  sense. 

CHARLES  M.  VAN  CLEVE. 
Yor'k,  August,  1912. 


CONTENTS 


CHAPTER   I 

PAGE 

Single-Entry  Bookkeeping  and  Double-Entry  Bookkeeping — 
The  Problem  to  be  Solved  is  Not  a  Mathematical 
Problem — The  Two  Classes  of  Text-Books — Double- 
Entry  Bookkeeping  Differs  from  the  Single-Entry 
System  in  that  It  Uses  Figurative  Language  ...  1 

CHAPTER  II 

There  Are  Two  Parties  to  Every  Ledger  Account — The  First 
and  Greatest  Problem  in  Double-Entry  Bookkeeping 
— The  Common  Theory  of  Double-Entry  Bookkeeping 
Violates  the  Laws  of  Rational  Speech 13 

CHAPTER  III 

Examples  Illustrating  the  Absurdity  of  Using  Relative 
Terms  from  a  Double  Standpoint — The  Defect  in  the 
Common  Form  of  Statement  Can  Not  be  Remedied  by 
Amending  the  Headings 23 

CHAPTER  IV 

Discussion  of  the   Technical   Terms  and   the  Fundamental 

Relations   of  Accounting 30 

CHAPTER  V 

Debts — The  Accruing  and  Maturing  of  Debts — Debts  are 
Recorded  as  if  Payable  on  Demand — Good  Debts  are 
Assets  and  Liabilities,  Bad  Debts  Represent  Losses 
and  Gains — The  Words  "Good"  and  "Bad"  as  Applied 
to  Debts  are  Not  Opposites 39 

CHAPTER  VI 
Abstract  and  Concrete  Conceptions 47 


x  CONTENTS 

CHAPTER  VII 

PAGE 

Double-Entry  Bookkeeping  Regards  all  Business  as  a  Matter 
of  Borrowing  and  Lending — Discussion  of  the  Idea  of 
Personification — Rule  for  Recording  Transactions  and 
Examples  Illustrating  It — The  Rule  for  Debiting  and 
Crediting  is  Never  Reversed 57 

CHAPTER  VIII 

Double-Entry  Bookkeeping  is  Duplicate-Entry  Bookkeeping 
— Accounts  of  Original  Entry  and  Accounts  of  Dupli- 
cate Entry — Schedule  of  Accounts — The  Accounts  of 
Original  Entry  Show  Actual  and  the  Accounts  of 
Duplicate  Entry  Show  Imaginary  Subdivisions  of  the 
Net  Capital — The  Accounts  of  an  Individual  or  of  a 
Firm  Can  be  Kept  in  the  Same  Form  as  Those  of  a 
Corporation 61 

CHAPTER  IX 

Examples  Illustrating  Duplicate  Entry — Difference  between 
the  Theory  of  Duplicate  Entry  and  the  Common 
Theory  of  Double-Entry  Bookkeeping 72 

CHAPTER   X 

Closing  the  Books — Examples  Illustrating  the  Process     .      .       83 

CHAPTER  XI 

» 

The  Object  of  Keeping  Accounts 95 

CHAPTER  XII 
Self-Contradictory    Debts 102 

CHAPTER  XIII 
The  Complete  Theory  of  Double-Entry  Bookkeeping  ...     108 

CHAPTER  XIV 
Example  Illustrating  the  Theory 117 


CONTENTS  xi 

CHAPTER   XV 

PAGE; 
The  Balance  Sheet 128 

CHAPTER  XVI 
Rules  for  Keeping  Books  by  the  Double-Entry  Method     .     .     136 

4 

CHAPTER  XVII 

Example  Illustrating  the  Rules — Profit  and  Loss       ...     145 

CHAPTER  XVIII 

Accounts  of  Duplicate  Entry  in  Partnership  Accounting  and 

in  Corporation  Accounting 155 

CHAPTER  XIX 

Debts  and  Obligations — Contingent  Liabilities — Analogy 
between  the  Language  of  Double-Entry  Bookkeeping 
and  Ordinary  Language 164 

CHAPTER  XX 
To  Open  the  Books  of  a  Corporation — Treasury  Stock     .      .     171 

CHAPTER  XXI 

Depreciation — Reserves  to  Meet  Fire  Losses — A  Common 
Error  in  the  Treatment  of  Such  Accounts — General 
Test  to  Which  Every  Set  of  Books  Should  Conform  .  176 

CHAPTER  XXII 
Sinking  Funds 184 

CHAPTER  XXIII 
Statement  of  a  Railroad  Company 194 

CHAPTER  XXIV 
Conclusion  203 


PRINCIPLES    OF 

DOUBLE-ENTRY    BOOKKEEPING 


CHAPTER    I 

SINGLE-ENTRY  BOOKKEEPING  AND  DOUBLE-ENTRY  BOOKKEEPING 
— THE  PROBLEM  TO  BE  SOLVED  IS  NOT  A  MATHEMATICAL 
PROBLEM THE  TWO  CLASSES  OF  TEXT-BOOKS — DOUBLE- 
ENTRY  BOOKKEEPING  DIFFERS  FROM  THE  SINGLE-ENTRY 
SYSTEM  IN  THAT  IT  USES  FIGURATIVE  LANGUAGE. 

Bookkeeping,  in  the  technical  sense  of  the  word,  deals  only 
with  values  as  expressed  in  terms  of  money.  It  had  its  origin 
in  the  necessity  of  recording  debts,  but  has  been  extended  to 
cover  all  financial  affairs.  The  purpose  of  bookkeeping,  then, 
is  to  keep  track  of  assets  and  liabilities  and  losses  and  gains. 

An  asset  is  anything  of  value  which  we  own  or  a  debt 
which  will  be  paid  to  us,  and  a  liability  is  a  debt  which  we 
will  have  to  pay;  while  losses  and  gains  are  changes  in  assets 
and  liabilities,  a  favorable  change  being  a  gain  and  an 
unfavorable  change  being  a  loss. 

In  any  systematic  method  of  accounting  there  must  be 
two  books,  or  two  types  of  books,  one  (Day-Book,  or  Journal) 
In^wHicli  transactions  are  recorded  in  the  order  of  their 
occurrence,  and  another  (Ledger)  in  which  the  items  pertain- 
ing to  each  heading  are  tabulated. 

There  are  two  recognized  systems  of  accounting:  Single- 
entry  bookkeeping  and  double-entry  bookkeeping;  but  the 
latter  has  supplanted  the  former  to  such  an  extent  that  the 
term  accounting  is  generally  used  and  understood  to  mean 
accounting  by  the  double-entry  method. 

To  illustrate  the  difference  between  the  two  svstems  we 


2  PRINCIPLES    OF 

will  assume  that  on  October  8th  we  buy  100  pairs  of  shoes  at 
$3.00  per  pair  from  \Vm.  Jones  on  account. 

By  the  single-entry  method  the  bookkeeper  records  the 
transaction  in  this  way : 

DAY-BOOK 

Oct.  8.    Bought  of  Wm.   Jones   on   account,   100   pairs  of 

shoes  at  $3.00 $300 

LEDGER 

Dr.  Wm.  Jones  Cr. 

(Debtor.)  (Creditor.) 


Oct.   8 $300 


And  then,  if  he  keeps  a  complete  record,  he  will  make  the 
following  entry  in  another  book,  which  is  not  called  a  ledger, 
but  is  of  that  type : 

MERCHANDISE  BOUGHT 
Oct.  8.     100  Pairs  of  shoes  at  $3.00 $300 

By  the  double-entry  method  the  bookkeeper  records  the 
transaction  in  this  form : 

JOURNAL 

Dr.  Cr. 

Oct.   8.    Merchandise    $300 

Wm.    Jones    $300 

100  Pairs  of  shoes  at  $3.00. 

LEDGER 
Dr.  Merchandise  Cr. 

Oct.     8 $300 

Dr.  ~Wm.  Jones  Cr. 

Oct.     8..  .   $300 


DOUBLE-ENTRY    BOOKKEEPING  3 

In  connection  with  every  transaction  there  are  two  things 
to  be  recorded.  In  the  case  given  above,  the  two  things  are 
the  fact  that  we  have  bought  $300  worth  of  merchandise  and 
the  fact  that  we  owe  Win.  Jones  $300.  The  latter  fact  is 
recorded  in  the  same  way  in  both  systems  of  accounting;  it 
is  recorded  by  making  the  entry  under  the  heading  "Wm. 
Jones,  Creditor/'  and  the  entry  means  simply  that  Wm.  Jones 
is  owed  $300.  But  the  fact  that  we  have  bought  $300  worth 
of  merchandise  is  recorded  in  the  single-entry  system  by 
making  the  entry  under  the  heading  "Merchandise  Bought," 
while  in  the  double-entry  system  the  entry  is  made  under  the 
heading  "Merchandise,  Debtor."  l^NJow^  to  say  that  merchan- 
dise is  debtor  to  the  amount  of  $300  means  that  merchandise 
owes  $300,  and  that  statement,  taken  literally,  is  nonsense. 
To  speak  of  inanimate  things  as  owing  or  being  owed  is  an 
absurdity. 

The  whole  problem  of  double-entry  bookkeeping  is 
involved  in  the  heading  "Merchandise,  Debtor,"  that  is  to  say, 
in  the  use  of  the  words  debtor  and  creditor  in  other  than 
personal  accounts.  The  purpose  of  this  treatise  is  (1)  to 
prove  that  bookkeepers  have  never  been  able  to  solve  the 
meaning  of  such  headings,  and  (2)  to  explain  what  the  mean- 
ing is. 

As  it  is  taught  and  practiced,  single-entry  bookkeeping  is 
an  incomplete  method  of  accounting;  but  that  is  not  because 
the  system  is  imperfect,  it  is  simply  because  it  has  never 
been  developed.  Double-entry  bookkeeping  was  invented  when 
the  art  of  accounting  was  still  in  an  elementary  stage,  and  as 
the  bookkeeper's  work  was  gradually  extended  to  cover  a 
greater  variety  of  accounts,  it  was  so  much  easier  to  keep 
the  books  by  the  double-entry  method  than  by  the  single-entry 
method  that  the  latter  system  was  never  carried  to  its  full 
development.  But,  as  a  matter  of  fact,  double-entry  is  the 
natural  method  of  accounting,  no  matter  whether  the  books 
be  kept  by  the  so-called  single-entry  system  or  by  the  so-called 


4  PKINCIPLES    OF 

double-entry  system.  In  single-entry  bookkeeping  the 
accountant  does  not  often  have  occasion  to  make  both  entries 
in  what  is  technically  called  the  ledger;  but  if  he  keeps  a 
complete  record,  he  will  carry  as  many  accounts  as  may  be 
needed,  outside  of  the  ledger,  under  such  headings  as  the 
following:  Contributions,  Withdrawals,  Cash  received,  Cash 
paid  out,  Merchandise  bought,  Merchandise  sold,  Paid  out 
for  expenses,  etc.,  etc. 

In  both  systems,  then,  the  same  amount  is  always  entered 
twice.  When  the  owner  contributes  money,  the  item  is 
entered  under  one  heading  as  a  contribution  and  under 
another  as  a  receipt  of  cash.  When  the  owner  withdraws 
money,  the  item  is  entered  under  one  heading  as  a  with- 
drawal and  under  another  as  a  disbursement  of  cash.  When 
merchandise  is  sold  on  account,  the  item  is  entered  under  one 
heading  as  a  sale  of  merchandise  and  under  another  to  record 
the  indebtedness  of  the  person  who  bought  it.  When  mer- 
chandise is  sold  for  cash,  the  item  is  entered  under  one  head- 
ing as  a  sale  of  merchandise  and  under  another  as  a  receipt 
of  cash.  When  money  is  paid  out  for  expenses,  the  item  is 
entered  under  one  heading  as  a  disbursement  of  cash  and 
under  another  to  show  the  amounts  paid  out  for  expenses. 

The  so-called  single-entry  system,  therefore,  can  accom- 
plish everything  which  can  be  accomplished  by  the  so-called 
frouble-entry  system,  but  it  takes  more  space  and  more  time 
to  do  it.  The  difference  between  the  two  systems  is  not  in 
the  number  of  entries  which  are  made,  but  in  the  wording  of 
the  headings  under  which  they  are  made.  In  single-entry 
bookkeeping  merchandise  account,  for  example,  is  in  this 
form: 


Merchandise  on  hand  at  the 
beginning  and  merchandise 
bought. 


Merchandise    sold    and    mer- 
chandise on  hand  at  the  close. 


DOUBLE-ENTRY    BOOKKEEPING  5 

In  double-entry  bookkeeping  the  account  is  in  this  form: 
Dr.  Merchandise  Cr. 


The  entries  are  exactly  the  same  in  both  cases,  and  in  both 
cases  the  difference  between  the  two  sides  is  the  loss  or  gain. 

Double-entry  bookkeeping  has  displaced  single-entry  book- 
keeping, not  because  it  is  a  more  complete  system  of  account- 
ing, but  because  single-entry  bookkeeping  is  ordinary  or  long- 
hand writing,  while  double-entry  bookkeeping  is  one  of  the 
most  compact  systems  of  short-hand  writing  that  have  ever 
been  invented. 

In  single-entry  bookkeeping  the  meaning  of  the  entries 
is  so  plain  that  any  person  of  ordinary  intelligence  can  under- 
stand them  without  any  previous  instruction  on  the  subject. 
It  is  very  evident  that  the  ledger  entry, 

Dr.  Wm.  Jones  Cr. 

$300 

means  that  Jones  is  owed  $300 ;  and  entries  under  such  head- 
ings as  "Cash  received,"  "Cash  paid  out,"  "Merchandise 
bought,"  "Merchandise  sold,"  etc.,  are  self-explanatory.  _In 
single-entry  bookkeeping  there  is  absolutely  nothing  that 
requires  explanation;  the  correctness  of  the  process  is  self- 
evident.  It  is  merely  a  record  of  the  proprietor's  financial 
affairs,  expressed  in  plain  language  and  simple  arithmetic. 
IButJn  double-entry  bookkeeping  the  use  of  the  words  debtor 
and  creditor  in  connection  with  titles  like  Cash,  Merchandise, 
Interest  and  Expense  certainly  differs  from  the  usage  which 
prevails  in  ordinary  language.  Single-entry  bookkeeping, 
then,  needs  only  to  be  described,  but  double-entry  bookkeeping 
needs  to  be  explained^! 


6  PRINCIPLES    OF 

It  will  be  noted,  however,  that  it  is  not  the  arithmetic 
of  bookkeeping  that  needs  explanation.  That  is  the  same  in 
both  systems  of  accounting,  and  is  so  simple  that  it  is  not 
worth  mentioning;  every  school-boy  knows  enough  arithmetic 
to  be  a  bookkeeper.  The  problem  of  double-entry  bookkeeping 
is  not  a  mathematical  problem ;  it  is  a  problem  which  involves 
the  study  of  the  use  of  language,  and  nothing  else. 

Among  the  terms  which  are  most  frequently  used  in 
accounting  are  the  words  debit  and  credit  and  the  words  asset 
and  liability.  These  are  very  simple  words  and  when  used  in 
the  ordinary  way,  as  in  single-entry  bookkeeping,  their  mean- 
ing is  perfectly  clear.  A  debit  entry  in  a  ledger  account 
means  that  the  person  owes  and  a  credit  entry  means  that  he 
is  owed;  and  when  we  speak  of  assets  and  liabilities,  we 
mean  (unless  otherwise  specified)  the  assets  and  liabilities  of 
the  proprietor  of  the  business  whose  accounts  we  are  keeping^ 
no  matter  whether  the  proprietor  be  an  individual,  a  firm 
or  a  corporation.  Yet,  simple  as  the  words  are,  I  believe  it 
to  be  a  fact  beyond  dispute  that  no  theory  of  double-entry 
bookkeeping  has  ever  been  advanced  in  which  both  of  these 
sets  of  words  are  used  in  a  rational  way. 

\  All  of  the  text-books  on  the  subject,  that  I  have  ever  read, 
may  be  divided  into  two  classes.  Most  of  them  use  the  words 
debit  and  credit  in  their  proper  sense,  which,  of  course, 
involves  the  necessity  of  personifying  the  headings  of  the 
accounts  when  they  do  not  represent  real  persons,  since  only 
a  person  can  owe  or  be  owed.  But  all  of  these  text-books 
inculcate  the  doctrine  that  in  double-entry  bookkeeping  the 
words  asset  and  liability  are  used  from  the  standpoint  of  an 
imaginary  agent  of  the  proprietor  (commonly  called  the 
"business")  standing  between  him  and  the  outside  world. 
Whatever  is  owed  to  the  business  by  outside  parties  the  busi- 
ness owes  to  the  proprietor,  and  whatever  is  owed  by  the 
business  to  outside  parties  the  proprietor  owes  to  the  business. 
In  other  words,  they  personify  the  business,  they  conceive  of 


DOUBLE-ENTBY   BOOKKEEPING  7 

the  business  as  a  person  capable  of  owing  and  of  being  owed, 
and  they  place  this  imaginary  person  in  such  a  4> 


his_asseis__aniL  liabilities  are  always  equal.  Their  use,  then, 
of  the  words  debit  and  credit  is  rational,  but  their  use  of 
the  words  asset  and  liability  is  irrational,  since  it  obliterates 
the  distinction  between  them;  every  item  which  is  asset  or 

j^  liability  at  all  is  both  an  asset  and  a  liability  of  the  business. 
"To  one  who  has  any  regard  for  mental  honesty  it  is  cer- 
tainly most  astonishing  that  the  text-books  which  argue  that 
it  is  possible  to  conceive  of  a  standpoint  from  which  assets 
and  liabilities  are  always  equal,  should  neglect  to  add  that( 
from  the  same  standpoint  losses  and  gains  are  also  equal./ 
From  the  standpoint  of  the  "business"  all  of  the  fundamental 
conceptions  of  accounting  cancel  each  other.  The  book- 
keeper who  professes  to  keep  his  accounts  from  such  a  stand- 
point is  simply  reasoning  in  a  circle;  his  argument  begins 
at  zero  and  ends  at  zero.  The  aggregate  of  the  assets  and 
liabilities  at  the  beginning  is  zero,  the  aggregate  of  the  assets 
and  liabilities  at  the  end  is  zero,  and  therefore  the  aggregate  of 
the  losses  and  gains  is  zero.  But  among  the  attempted 
explanations  of  double-entry  bookkeeping,  this  is  the  one 
which  has  made  the  deepest  impression  upon  the  thoughts,  the 
language  and  the  customs  of  the  bookkeeper,  and  therefore 
when  I  speak  of  the  common  or  current  theory,  I  mean  the 
theory  that  double-entry  bookkeeping  deals  with  the  assets 
and  liabilities,  not  of  the  proprietor,  but  of  the  "business" — 

y       a  theory  which  is  so  plainly  false  that  it  would  seem  incredible 
that  a  rational  mind  could  ever  be  misled  by  it. 

pther  text-books  reject  the  idea  of  personification 
altogether,  claiming  that  the  explanation  of  double-entry 
bookkeeping  is  found  in  the  equation,  Assets  —  Liabilities  = 
Net  Capital,  which  is  true  by  definition.  X^Their  use,  then, 
of  the  words  asset  and  liability  is  rational,  since  they  use 
them  from  the  natural  standpoint,  the  standpoint  of  the 
proprietor;  but  they  can  use  the  words  debit  and  credit  in 


8  PRINCIPLES    OF 

their  proper  sense  only  in  personal  accounts.  They  are  forced 
to  take  the  position  that  in  other  accounts  these  words  convey 
no  idea  of  owing  or  being  owed,,  that  to  debit  means  simply  to 
make  an  entry  on  the  left-hand  side  and  to  credit  means  to 
make  an  entry  on  the  right-hand  side.  Text-books  of  this 
Ikind  fail  to  satisfy  the  intelligent  reader,  because  they  do  not 
I  add  anything  to  what  he  knew  before.  '  The  relations  between 
assets,  liabilities  and  net  capital  are  so  exceedingly  simple 
that  they  may  be  called  matters  of  common  knowledge. 
Every  person  knows  that  to  determine  how  much  he  is  worth 
he  must  deduct  the  total  of  his  liabilities  from  the  total  of 
his  assets,  and  he  also  knows  that  increase  in  the  amount 
which  he  is  worth  is  gain  and  decrease  is  loss.  If  that  is  all 
that  there  is  to  the  problem  of  double-entry  bookkeeping, 
there  is  no  problem. 

\  The  problem  of  double-entry  bookkeeping  is  not  to  explain 
the  mathematical  basis  of  accounting — that  is  so  simple  that 
to  a  person  of  ordinary  intelligence  there  is  nothing  to  explain 
— the  problem  is  to  explain  the  use  of  the  words  debtor  and 
creditor  in  other  than  personal  accounts,  withoujt  excluding 
the  rational  use  of  the  terms  asset  and  liability.  To  affirm 
that  in  such  cases  the  words  debtor  and  creditor  have  no 
meaning  at  all  is  simply  to  beg  the  question.  If  double-entry 
bookkeeping  uses  words  which  mean  nothing,  single-entry 
bookkeeping  is  the  only  rational  system  of  accounting. 

Of  the  two  classes  of  text-books  described  above  (and, 
so  far  as  I  know,  these  two  classes  cover  all  of  the  text-books 
that  have  ever  been  written  on  the  subject),l])oth.  are  partly 
right  and  partly  wrong^/  Those  of  the  first  class  are  right  in 
personifying  the  headings  of  the  accounts  and  wrong  in 
personifying  the  business,  while  those  of  the  second  class  are 
right  in  rejecting  the  personification  of  the  business  and 
wrong  in  rejecting  the  personification  of  the  headings  of  the 
accounts,  since  without  that  idea  their  language  is  unin- 
telligible. As  long  as  bookkeepers  speak  of  debiting  Cash 


DOUBLE-ENTKY   BOOKKEEPING  9 

and  crediting  Merchandise  to  record  a  sale  of  merchandise  for 
cash,  they  must  admit  that  Merchandise  is  the  imaginary 
person  from  whom  we  are  supposed  to  borrow  the  merchandise 
which  we  give  to  the  purchaser,  and  that  Cash  is  the  imagin- 
ary person  to  whom  we  are  supposed  to  lend  the  money  which 
we  receive  from  the  purchaser;  or  else  they  must  admit  that 
the  language  which  they  use  consists  of  words  without  sense. 
If  Cash  means  cash  and  Merchandise  means  merchandise, 
then  to  speak  of  debiting  and  crediting  them  is  the  height  of 
absurdity. 

When  the  proprietor  of  the  business  whose  accounts  we 
are  keeping  sells  merchandise  to  John  Smith  on  account, 
there  is  one  way,  and  only  one  way,  to  explain  the  entries 
which  are  made  to  record  the  transaction.  We  must  pretend 
that  the  proprietor  borrows  the  amount  from  the  person 
called  Merchandise  and  lends  it  to  the  person  called  Smith, 
therefore  Smith  owes  the  proprietor  and  the  proprietor  owes 
Merchandise;  we  debit  Smith  and  credit  Merchandise.  The 
reader  will  observe  that  this  explanation  does  not  introduce 
any  intermediate  party,  that  it  does  not  involve  any  such 
imaginary  person  as  the  "business."  The  proprietor  is  the 
one  to  whom  Smith  owes  the  debt  and  the  proprietor  is  the 
one  who  owes  the  debt  to  Merchandise.  / 

In  bookkeeping  form,  if  the  headings  were  written  in 
full,  the  entries  to  record  the  transaction  would  be  as  follows : 

JOURNAL 

Dr.  Cr. 

John  Smith,  to  Proprietor  (1)     $100 

Merchandise,  to  Proprietor   (2)  $100 

LEDGER 

Dr.  John  Smith  Cr. 
To  Proprietor 

(1)         $100 


10  PRINCIPLES    OF 

Dr.  Merchandise  Or. 

To  Proprietor 


(2)         $100 


These  entries,  both  those  in  the  journal  and  those  in  the 
ledger,  are  to  be  read  as  if  they  were  written  in  this  form: 

John  Smith,  to  proprietor,  debtor,  $100, 

Merchandise,  to  proprietor,  creditor,  $100, 
and  they  mean  that  John  Smith  owes  $100  to  the  proprietor 
and  that  the  person  called  Merchandise  is  owed  $100  by  the 
proprietor.  In  bookkeeping,  in  order  to  take  advantage  of 
a  shorter  form  of  expression,  we  always  imagine  ourselves  in 
the  position  of  the  proprietor,  no  matter  whether  the  pro- 
prietor be  an  individual,  a  firm  or  a  corporation.  We  would 
say,  then,  that  the  above  entries  mean  that  John  Smith  owes 
us  $100  and  that  we  owe  $100  to  the  person  called 
Merchandise. 

It  is  very  evident  that  when  we  debit  Smitli  we  are  using 
language  in  its  literal  sense;  we  mean  exactly  what  we  say; 
we  mean  that  Smith  owes  us  $100.  But  it  is  equally  evident 
that  when  we  credit  Merchandise  we  do  not  mean  that  we 
actually  owe  anything  to  a  person  of  that  name,  since  in 
reality  there  is  no  such  person ;  we  merely  pretend  that  there 
is  a  person  called  Merchandise  and  that  we  borrowed  $100 
from  him.  In  this  case  we  are  using  figurative  language; 
but  it  is  language  which  has  a  clear  and  definite  meaning,  a 
meaning  which  it  is  easy  to  translate  into  ordinary  language 
and  to  express  in  terms  of  asset  and  liability  and  of  loss 
and  gainj 

TKe  use  of  such  language  is  what  distinguishes  double- 
entry  bookkeeping  from  single-entry  bookkeeping.  The  whole 
difference,  and  the  only  difference,  between  the  two  systems  of 
accounting  is  in  the  fact  that  single-entry  bookkeeping  always 
uses  literal  language,  while  double-entry  bookkeeping  always 


DOUBLE-ENTKY   BOOKKEEPING  11 

uses  figurative  language  except  when  speaking  of  persons.  As 
soon  as  one  understands  the  figurative  language  which  it  uses, 
double-entry  bookkeeping  is  just  as  simple  as  single-entry 
bookkeeping — and  much  more  compact. 

\  In  single-entry  bookkeeping  Cash  means  cash.  Merchan- 
dise means  merchandise.  Interest  means  interest.  Expense 
means  expense.  But  in  double-entry  bookkeeping  Cash  does 
not  mean  cash;  it  means  the  imaginary  person  who  owes  the 
amount  of  the  cash.  Merchandise  does  not  mean  merchan- 
dise; it  means  the  imaginary  person  who  owes  the  amount 
of  the  merchandise.  Interest  does  not  mean  interest;  it 
means  the  imaginary  person  who  owes  or  is  owed  the  amount 
of  the  interest.  Expense  does  not  mean  expense ;  it  means  the 
imaginary  person  who  owes  the  amount  of  the  expenses.  Net 
Capital  does  not  mean  net  capital;  it  means  the  person  (real 
in  the  case  of  an  individual  owner,  imaginary  in  the  case  of 
a  firm  or  a  corporation)  who  is  owed  or  owes  the  amount  of 
the  net  capital.  Net  Capital,  then,  is  the  proprietor,  while 
the  net  capital  is  the  net  amount  which  he  is  owed  or  owes. 
When  it  is  the  net  amount  which  he  is  owed,  we  say  that  the 
net  capital  is  positive;  when  it  is  the  net  amount  which  he 
owes,  we  say  that  the  net  capital  is  negative. 

All  of  the  above  parties,  except  the  proprietor  (Net 
Capital),  are  outside  parties.  There  are  only  the  two  sides 
in  accounting,  there  is  no  intermediate  party.  In  double- 
entry  bookkeeping  we  have  the  proprietor  on  the  one  side 
and  the  outside  parties  on  the  other  side,  and  the  term  "out- 
side party"  includes  all  parties  that  are  not  included  in  the 
term  "proprietor."  Any  party  that  owes  the  proprietor  or 
is  owed  by  the  proprietor  is  an  outside  party,  no  matter 
whether  the  name  of  that  party  be  Smith,  or  Jones,  or  Kobin- 
son,  or  Cash,  or  Merchandise,  or  Interest,  or  Expense. 

In  the  practice  of  double-entry  bookkeeping  we  have  a  very 
peculiar  state  of  affairs,  one  which  does  not  exist  in  any 
other  calling.  We  have  an  occupation  so  commonplace  in 


12  PEINCIPLES    OF 

its  nature  that  those  who  engage  in  it  are  apt  to  be  the  most 
matter-of-fact  and  the  most  literal-minded  of  men;  yet  their 
occupation,  prosaic  as  it  is,  compels  them  to  use  language 
which  is  entirely  figurative,  except  as  applied  to  personal 
accounts — and  figurative  language  is  the  language  of  poetry. 
It  is  the  only  case  in  which  the  use  of  poetical  language  is 
an  essential  part  of  an  occupation  that  pertains  strictly  to 
practical  affairs.  Naturally,  the  people  who  are  compelled 
to  use  this  language  do  not  understand  it,  and  the  fact  that 
accountants  do  not  understand  their  own  language  is  the 
source  of  all  the  confusion  of  thought  that  exists  on  the 
subject  of  double-entry  bookkeeping. 


DOUBLE-ENTRY   BOOKKEEPING  13 


CHAPTER    II 

THERE  ARE  TWO  PARTIES  TO  EVERY  LEDGER  ACCOUNT — THE 
FIRST  AND  GREATEST  PROBLEM  IN  DOUBLE-ENTRY  BOOK- 
KEEPING  THE  COMMON  THEORY  OF  DOUBLE-ENTRY 

BOOKKEEPING  VIOLATES  THE  LAWS  OF  RATIONAL  SPEECH. 

Double-entry  bookkeeping  keeps  all  the  records  in  the 
form  of  debts,  and  the  very  foundation  of  the  whole  system, 
/the  thing  which  makes  double-entry  bookkeeping  possible,  is 
the  fact  that  if  a  person  owes  anything  he  must  owe  it  to 
someone  else,  that  debt  is  a  relation  involving  two  parties. 

The  bookkeeper  knows  that  a  ledger  account  is  a  record 
of  debt  and  that  there  must  be  two  parties  to  a  debt;  he 
knows  that  the  person,  real  or  imaginary,  whose  name  heads 
the  account  is  one  of  the  parties,  but  he  has  only  the  vaguest 
ideas  as  to  the  identity  of  the  other  party.  His  confusion  of 
thought  on  this  point  is  shown  by  the  form  in  which  he 
makes  his  entries.  In  recording  a  transaction — a  sale  of 
merchandise  to  Thos.  Brown  on  account,  for  example — he 
always  makes  the  journal  entries  in  this  way : 

Dr.  Cr. 

Thos.    Brown    $50 

To  Merchandise   $50 

And  he  often  makes  the  ledger  entries  in  this  form : 

Dr.  Thos.  Brown  Cr. 


To    Merchandise $50 

Dr.  Merchandise  Cr. 

By   Thos.    Brown $50 

If  those  entries   mean   what  they  say,   they  mean  that 
Brown  is  debtor  to  Merchandise  and  Merchandise  is  creditor 


14 


PRINCIPLES    OF 


to  Brown.  Both  entries  mean  exactly  the  same  thing.  The 
one  puts  the  statement  in  the  active  voice  and  says  that 
Brown  owes  $50  to  Merchandise;  the  other  puts  the  same 
statement  in  the  passive  voice  and  says  that  Merchandise  is 
owed  $50  by  Brown.  In  that  case  the  transaction  can  be 
explained  only  in  this  way:  Brown  borrows  from  Merchan- 
dise, therefore  Brown  owes  Merchandise;  Merchandise  lends 
to  Brown,  therefore  Merchandise  is  owed  by  Brown. 

It  is  not  difficult  to  locate  the  fallacy  in  that  view  of  the 
matter.  The  bookkeeper  professes  to  be  keeping  track  of  the 
business  of  the  proprietor,  but  he  records  transactions  as  if 
the  proprietor  had  nothing  to  do  with  them;  he  presents  the 
play  of  "Hamlet"  with  Hamlet  left  out.  Naturally,  the  result 
of  his  efforts  is  not  very  intelligible. 

The  absurdity  of  the  above  form  becomes  more  evident 
when  we  take  a  ledger  account  in  which  a  number  of  entries 
are  shown.  Cash  account,  for  example,  often  appears  like 
this: 


Dr. 


Cash 


Cr. 


To   Merchandise $800 

To     Interest 200 

To  John  Smith 500 


By  Bills  Payable $400 

By    Expense 100 


Reading  those  entries  exactly  as  they  are  written,  they  say 
that  Cash  owes  $800  to  Merchandise,  $200  to  Interest  and 
$500  to  John  Smith,  and  that  Cash  is  owed  $400  by  Bills 
Payable  and  $100  by  Expense.  The  result  is  that  the  book- 
keeper cannot  make  an  intelligent  reply  to  the  first  question 
that  naturally  suggests  itself.  To  whom  does  Cash  owe  the 
balance  of  the  account? 

As  soon  as  one  recognizes  the  fact  that  the  proprietor  takes 
part  in  every  transaction  and  that  the  proprietor  is  the  second 
party  in  every  entry  which  is  made  to  record  a  transaction, 


DOUBLE-ENTKY    BOOKKEEPING  15 

the  whole  subject  becomes  perfectly  clear.  The  transactions 
which  enter  into  the  account  given  above  are  as  follows:  > 

The  proprietor  borrows  $800  from  Merchandise  and  lends 
it  to  Cash,,  therefore  Cash  owes  the  proprietor  and  the  pro- 
prietor owes  Merchandise. 

The  proprietor  borrows  $200  from  Interest  and  lends  it 
to  Cash,,  therefore  Cash  owes  the  proprietor  and  the  pro- 
prietor owes  Interest. 

The  proprietor  borrows  $500  from  John  Smith  and  lends 
it  to  Cash,  therefore  Cash  owes  the  proprietor  and  the  pro- 
prietor owes  Smith. 

The  proprietor  borrows  $400  from  Cash  and  lends  it  to 
Bills  Payable,  therefore  Bills  Payable  owes  the  proprietor 
and  the  proprietor  owes  Cash. 

The  proprietor  borrows  $100  from  Cash  and  lends  it  to 
Expense,  therefore  Expense  owes  the  proprietor  and  the  pro- 
prietor owes  Cash. 

These  transactions  would  be  recorded  in  the  journal  as 
follows : 

Dr.  Cr. 

Cash,  to  Proprietor (1)     $800 

Merchandise,  to  Proprietor (2)  $800 

Cash,  to  Proprietor (3)       200 

Interest,   to   Proprietor (4)  200 

Cash,  to   Proprietor ( 5 )       500 

John  Smith,  to  Proprietor (6)  500 

Bills  Payable,  to  Proprietor (7)       400 

Cash,   to  Proprietor (8)  400 

Expense,  to  Proprietor (9)       100 

Cash,  to  Proprietor (10)  100 

And  in  the  ledger  cash  account  would  appear  in  this  form : 

Dr.  Cash  Cr. 

To  Proprietor 


(1)  $800 
(3)  200 
(5)  500 


(8)    $400 
(10)     100 


16  PRINCIPLES    OF 

In  that  form  the  account  is  complete  and  its  meaning 
is  clear;  it  means  that  Cash  owes  $1,500  to  the  proprietor 
and  is  owed  $500  by  the  proprietor,  therefore  the  net  result 
is  that  Cash  owes  $1,000  to  the  proprietor.  The  debit  entries 
show  the  amounts  which  the  person  called  Cash  has  received 
from  the  proprietor  and  the  credit  entries  show  the  amounts 
which  he  has  given  to  the  proprietor,  therefore  he  should 
have  the  balance  on  hand.  |  The  person  called  Cash  is  imagin- 
ary, but  the  safe  in  which  mTkeeps  the  money  and  the  money 
which  he  keeps  in  it  are  real;  therefore  the  amount  which  he 
has  on  hand  at  any  given  time  can  be  determined  by  counting 
the  cash.  If  the  amount  which  the  person  called  Cash  has  on 
hand  agrees  with  the  amount  which  he  owes  to  the  proprietor 
the  debt  is  good  and  therefore  from  the  standpoint  of  the 
proprietor  it  represents  an  asset. 

Many  of  the  modern  text-books  object  to  the  use  of  the 
words  "To"  and  "By"  in  ledger  entries,  but  they  do  it  simply 
on  the  ground  that  the  words  are  unnecessary ;  and,  so  far  as 
I  know,  none  of  them  object  to  the  use  of  the  word  "To"  in 
journal  entries.  The  above  discussion  brings  out  the  fact 
that  the  use  which  the  bookkeeper  makes  of  the  word  "To" 
in  journal  entries,  and  of  the  words  "To"  and  "By"  in  ledger 
entries,  is  not  merely  unnecessary ;  it  is  positive  proof  that  he 
does  not  know  what  his  entries  mean. 

In  practice  the  bookkeeper  never  writes  the  names  of  both 
parties  to  an  account;  he  heads  each  of  his  accounts  with  the 
name  of  the  first  party  only.  Now,  so  far  as  the  actual  work 
of  keeping  books  is  concerned,  I  do  not  advocate  any  change 
in  that  respect.  The  number  of  first  parties  is  unlimited, 
but  there  are  only  two  second  parties  in  the  whole  ledger — 
the  proprietor  and  one  other — and  therefore  it  would  be  a 
useless  repetition  to  write  the  name  of  the  second  party; 
it  is  easy  to  distinguish  the  two  classes  of  accounts  without 
it.  >But  in  teaching  double-entry  bookkeeping,  at  all  events 


DOUBLE-ENTEY   BOOKKEEPING  17 

in  the  beginning,  the  name  of  the  second  party  should  bej        \ 
written  in  every  case.  ^ 


n  order  to  understand  the  meaning  of  his  entries,  the 
very  first  thing  that  the  bookkeeper  needs  is  to  know  who 
the  second  party  is  in  each  account;  yet  I  have  never  seen  a 
text-book  that  even  mentions  the  fact  that  there  must  be  two 
parties  to  a  ledger  account^  The  ignoring  of  the  second  party 
makes  the  teaching  of  the  text-books  utterly  incoherent;  they 
fail  to  establish  any  relation  between  the  various  accounts, 
since  it  is  only  through  the  second  party  that  the  accounts 
are  connectej^J  Why  should  we  record  the  fact  that  Jones 
owes  $400,  or  that  Brown  is  owed  $300,  or  that  Cash  owes 
$500,  or  that  Interest  is  owed  $200  ?  What  difference  does 
it  make  to  us  what  these  parties  owe  or  are  owed  —  unless 
they  owe  us  or  are  owed  by  us,  unless  we  are  the  second 
party  in  each  of  these  accounts?  The  entries  have  no  mean- 
ing unless  the  bookkeeper  knows  who  the  second  party  is 
in  each  case,  and  he  cannot  know  that  unless  he  realizes  the 
fact  that  in  the  figurative  language  of  double-entry  book- 
_Jkeeping  we  are  always  borrowing  and  lending.  We  borrow 
from  Merchandise  and  lend  to  Jones,  therefore  Jones  owes  us 
and  we  owe  Merchandise  ;  we  debit  Jones  and  credit  Merchan- 
dise. We  borrow  from  Brown  and  lend  to  Merchandise, 
therefore  Merchandise  owes  us  and  we  owe  Brown;  we  debit 
Merchandise  and  credit  Brown.  We  borrow  from  Merchan- 
dise and  lend  to  Cash,  therefore  Cash  owes  us  and  we  owe 
Merchandise;  we  debit  Cash  and  credit  Merchandise.  We 
borrow  from  Cash  and  lend  to  Expense,  therefore  Expense 
owes  us  and  we  owe  Cash  ;  we  debit  Expense  and  credit  Cash. 
We  borrow  from  Interest  and  lend  to  Cash,  therefore  Cash 
owes  us  and  we  owe  Interest;  we  debit  Cash  and  credit 
Interest. 

It  is  very  evident  that  the  proprietor  is  the  second  party 
in  every  one  of  the  accounts  in  which  these  transactions  are 
recorded;  every  entry  records  a  debt  owed  either  to  the 


18  PRINCIPLES    OF 

proprietor  or  by  the  proprietor.  But  it  is  equally  evident 
that  the  proprietor  cannot  be  the  second  party  in  all  accounts. 
When  the  owner  is  an  individual  the  bookkeeper  always 
carries  what  is  called  the  proprietor's  account,  net  capital 
account,  and  in  that  account  the  proprietor  is  the  first  party. 
The  question  therefore  arises,  Who  is  the  second  party  in  the 
proprietor's  account  ? 

That  seems  to  be  a  very  simple  question — and  it  is  a 
simple  question,  as  the  reader  will  find  when  he  comes  to 
Chapter  VIII — but  nevertheless  it  is  the  first  and  greatest 
problem  in  double-entry  bookkeeping.  In  fact,  it  would 
hardly  be  going  too  far  to  say  that  it  is  the  only  problem 
in  double-entry  bookkeeping,  because,  when  that  has  once 
been  solved,  the  rest  of  it  follows  almost  as  a  matter  of 
course. 

The  accountant  has  never  been  able  to  solve  that  problem. 
The  only  answer  to  the  question  that  he  has  ever  been  able 
to  devise  is  to  the  effect  that  the  proprietor  is  not  the  second 
party  in  any  of  the  accounts,  that  the  "business"  is  the  second 
party  in  the  proprietor's  account  and  in  all  the  other  accounts 
as  well.  To  be  sure,  he  does  not  make  that  statement  in  so 
many  words,  he  never  mentions  the  fact  that  there  are  two 
parties  to  a  ledger  account;  but  nevertheless  that  is  the 
position  which  he  takes. 

When  the  accounts  are  closed  and  the  balances  are  brought 
down  to  new  account,  the  total  of  the  balances  brought  down 
as  debits  always  equals  the  total  of  the  balances  brought  down 
as  credits,  and  the  bookkeeper  says  that  these  balances  repre- 
sent the  assets  and  liabilities  of  the  "business."  Now,  if  that 
is  the  case,  the  balances  which  are  brought  down  as  debits 
must  represent  debts  owed  to  the  business,  and  the  balances 
which  are  brought  down  as  credits  must  represent  debts  owed 
by  the  business,  and  therefore  the  business  must  be  the  second 
party  in  every  account.  [According  to  that  view  of  the  matter, 
the  books  are  kept,  not  from  the  standpoint  of  the  proprietor, 


DOUBLE-ENTRY    BOOKKEEPING  19 

but  from  the  standpoint  of  the  business,  and  assets  and  lia- 
bilities are  always  equal. 

There  are  two  incontestable  objections  to  that  theory. 
Onels  based  upon  the  mathematical  axiom  that  if  two  variable 
quantities  are  always  equal  the  changes  in  those  quantities 
must  be  equal;  therefore,  if  assets  and  liabilities  are  always 
equal,  losses  and  gains  are  always  equal.  The_other  objection 
is  based  upon  the  principles  which  govern  the  construction  of 
language.  The  doctrine  of  equal  assets  and  liabilities  makes 
the  business  an  intermediate  party  standing  between  the 
proprietor  and  the  outside  world,  a  party  that  faces  both 
ways;  therefore  the  standpoint  of  the  business  is  a  double 
standpoint — in  harmony  with  that  of  the  proprietor,  looking 
one  way,  and  in  opposition  to  it  looking  the  other  way.  Now 
the  words  asset  and  liability  are  relative  terms,  and  when 
the  bookkeeper  speaks  of  the  assets  and  liabilities  of  the  busi- 
ness he  is  using  relative  terms  from  a  double  standpoint — a 
practice  which  is  absolutely  prohibited  by  one  of  the  funda- 
mental laws  of  rational  speech. 

That  law  is  not  a  rule  of  grammar;  it  is  a  self-evident 
truth.  It  applies,  not  to  one  language,  but  to  all  languages. 
It  is  as  fixed  and  unchangeable  as  the  law  of  gravity,  and  to 
the  extent  to  which  it  is  violated,  rational  speech  is  an  impos- 
sibility. Among  intelligent  men  the  accountant  is  the  only 
one  who  habitually  violates  that  law,  and  in  consequence  of 
his  indiscriminate  use  of  relative  terms  he  has  evolved  a  Ian-  ' 
guage  that  neither  himself  nor  anyone  else  can  understand, 
a  jargon  in  which  it  is  practically  impossible  to  express  a; 
clear  idea. 

For  illustration  we  may  take  the  item  which  often 
appears  among  his  liabilities  under  the  heading  "Keserved  for 
Taxes."  \JQa~designate  an  item  as  reserved  for  taxes  and  to 
classify  that  item  as  a  liability  is  arrant  nonsense.  The  taxes 
are  a  liability,  but  the  amount  which  is  reserved  for  taxes 
(if  there  is  anything  reserved)  is  an  asset.!  We  may  reserve 


20  PEINCIPLES    OF 

an  asset,  and  we  may  conceive  of  reserving  net  asset;  but 
to  speak  of  a  reserve  as  a  liability,  or  of  a  liability  as  a 
reserve,  is  one  of  the  characteristic  incongruities  of  book- 
keeping. 

If  the  taxes  have  accrued  (no  matter  whether  due  or  not), 
the  item  represents  a  liability,  the  same  as  any  other;  but  in 
that  case  it  does  not  represent  a  reserve.  If,  however,  the 
basis  on  which  the  taxes  are  to  be  computed  cannot  be  deter- 
mined until  later,  then  it  is  proper  to  take  the  view  that  as 
yet  no  taxes  have  accrued,  and  to  indicate  an  estimated 
amount  of  the  net  capital  as  reserved  for  the  purpose  of 
paying  the  taxes  when  they  accrue  or  if  they  accrue;  but  in 
that  case  the  item  does  not  represent  a  liability,  since  as 
yet  no  liability  has  accrued. 

Accountants  frequently  deplore  their  lack  of  an  accurate 
nomenclature,  but  they  seem  to  be  unable  to  locate  the  source 
of  the  difficulty;  they  seem  to  be  totally  oblivious  of  the  fact 
that  their  whole  technical  language,  as  they  have  developed 
it,  is  founded  upon  a  violation  of  the  laws  of  rational  speech. 
What  can  be  expected  in  the  way  of  accuracy  in  the  use  of 
words  from  men  who  reverse  the  standpoint  from  which  they 
use  relative  terms;  who  say  that  the  proprietor's  assets  are 
to  be  called  assets,  that  his  liabilities  are  to  be  called  lia- 
bilities, and  that  the  excess  of  his  assets  over  his  liabilities 
is  also  to  be  called  a  liability,  because,  although  it  is  net 
asset  from  the  standpoint  of  the  proprietor,  it  is  liability 
from  the  standpoint  of  the  "business"?  Following  that  line 
of  argument,  one  might  say  that  what  Smith  owes  to  the 
proprietor  is  to  be  counted  as  an  asset,  that  what  the  pro- 
prietor owes  to  Jones  is  to  be  counted  as  a  liability,  and  that 
what  Brown  owes  to  the  proprietor  is  also  to  be  counted  as  a 
liability,  because,  although  it  is  asset  from  the  standpoint 
of  the  proprietor,  it  is  liability  from  the  standpoint  of  Brown. 

If  accountants  really  want  to  know  why  they  are  not 
recognized  as  practicing  a  profession,  the  reason  is  not  far 


DOUBLE-ENTKY    BOOKKEEPING  21 

to  seek.  It  is  because  they  base  their  language  upon  a 
reversal  in  the  use  of  words,  and  their  logic  upon  a  contra- 
diction in  terms.  It  is  because  the  only  theory  which  they 
have  ever  been  able  to  devise  in  explanation  of  their  opera- 
tions is  one  that  calls  net  asset  a  liability  and  net  liability 
an  asset.  It  is  because  the  technical  language  of  accounting, 
instead  of  being  the  embodiment  of  clearness  of  thought  and 
accuracy  of  expression,  is  an  unintelligible  jargon  of  self- 
contradictions. 

A  technical  language  that  calls  a  reserve  a  liability  or  a 
liability  a  reserve  is  a  disgrace  to  the  people  who  use  it. 
A  technical  language  in  which  one  says  that  surplus  is  a 
liability  and  then  says  that  the  net  gain  is  to  be  added  to  the 
surplus,  is  an  outrage  upon  common  sense.  One  would  sup- 
pose that  any  bookkeeper  would  have  intelligence  enough  to 
know  that  if  the  item  under  the  head  of  "Surplus"  is  a 
liability,  increase  in  the  amount  of  that  item  is  loss;  and 
conversely,  if  gain  increases  the  surplus,  surplus  is  not  a 
liability.  <  One  would  suppose  that  any  bookkeeper  who  says 
that  an  account  payable  is  a  liability  and  that  capital  stock 
is  also  a  liability,  would  have  intelligence  enough  to  know 
that  he  is  simply  reversing  the  use  of  words,  that  the  one 
represents  a  liability  of  the  stockholders  and  the  other  repre- 
sents all  or  part  of  the  net  liability  to  the  stockholders— 
and  the  net  liability  to  the  stockholders  is  their  net  assetj 
One  would  suppose  that  any  bookkeeper — or  for  that  matter, 
any  man  who  has  intelligence  enough  to  tell  his  right  hand 
from  his  left — would  have  intelligence  enough  to  recognize 
the  utter  absurdity  of  using  the  words  asset  and  liability 
from  the  standpoint  of  a  party  that  faces  both  ways.  From 
such  a  standpoint  there  is  no  such  thing  as  right  or  left, 
nor  is  there  any  such  thing  as  asset  or  liability.  Eelative 
terms  have  no  meaning  at  all  unless  they  are  used  from  a 
single  fixed  standpoint,  and  the  only  fixed  standpoint  in 


22  PRINCIPLES    OF 

accounting    is    that    of    the    proprietor    or    the    proprietors 
collectively. 

A  building  is  a  building,  no  matter  from  what  stand- 
point one  looks  at  it;  but  the  building  is  an  asset  only  from 
the  standpoint  of  the  person  who  owns  it.  The  word  building 
is  an  absolute  term,  but  the  words  asset  and  liability  are 
relative  terms,  and  relative  terms  are  not  to  be  used  from  a 
double  standpoint. 


DOUBLE-ENTRY   BOOKKEEPING 


CHAPTER   III 


EXAMPLES  ILLUSTRATING  THE  ABSURDITY  OF  USING  RELATIVE 
TERMS  FROM  A  DOUBLE  STANDPOINT — THE  DEFECT  IN  THE 
COMMON  FORM  OF  STATEMENT  CAN  NOT  BE  REMEDIED 
BY  AMENDING  THE  HEADINGS. 

To  illustrate  the  absurdity  of  the  bookkeeper's  use  of 
relative  terms,  [wewill  assume  that  four  men,  A,  B,  C,  D, 
are  standing  in  the  order  indicated  by  the  letters,  all  of  them 
facing  the  north.  B  says  to  the  others  that  he  can  count 
as  many  of  them  on  his  left  side  as  on  his  right,  and  the 
others  dispute  the  statement.  Still  facing  the  north  B  counts 
one  on  the  left  and  two  on  the  right;  then  he  turns  around 
and  facing  the  south  counts  two  on  the  left  and  one  on  the 
right,  and  claims  that  he  has  proved  his  statement  because  he 
has  counted  three  on  each  side. 

That  is  about  as  stupid^atrick  as  could  well  be  imagined ; 
in  the  vernacular  of  the  street  it  would  be  called  "horse-play" ; 
yet  it  illustrates  exactly  what  the  bookkeeper  does  when  he 
makes  a  statement  like  the  following: 


Assets 

Cash    $15,000 

Merchandise    95,000 

Accounts  Receivable  . .     14,000 
Bills   Receivable    16,000 

$140,000 


Liabilities 

Capital  Stock    $100,000 

Surplus     20,000 

Accounts  Payable    8,000 

Bills  Payable    12,000 

$140,000 


The  only  possible  excuse  that  anyone  can  offer  for  such  a 
form  of  statement  is  to  say  that  it  shows  the  assets  and, 
liabilities  of  an  intermediate  party,  a  party  that  faces  both 
ways'.  |In  the  case  of  an  individual  proprietor  the  bookkeeper  * 
thinks  tKat  this  party  is  the  business,  in  partnership  account-  / 
ing  he  thinks  that  it  is  the  firm,/and  in  corporation  account- 


24  PRINCIPLES    OF 

f   ing  he  thinks  that  it  is  the  company.     Therefore,  to  explain 
!    the  above  statement  the  bookkeeper  takes  a  position  looking 
\  away  from  the  stockholders,  and  says  that  the  amounts  under 
\the  headings  Cash,  Merchandise,  Accounts  Receivable  and 
Bills  Eeceivable  are  assets,  because  outside  parties  owe  them 
to  the  company,  and  that  the  amounts  under  the  headings 
Accounts  Payable  and  Bills  Payable  are  liabilities,  because 
the  company  owes  them  to  outside  parties.     Then  he  turns 
j  around  and  looking  toward  the  stockholders  says  that  the 
\  amounts  under  the  headings  Cash,  Merchandise,  Accounts 
Receivable  and  Bills  Eeceivable  are  liabilities,  because  the 
\  company  owes  them  to  the  stockholders,  and  that  the  amounts 
Innder  the  headings  Accounts  Payable  and  Bills  Payable  are 
assets,  because  the  stockholders  owe  them  to  the  company. 
/The  total  liability  of  the  company  to  the  stockholders  is 
$140,000  and  the  total  liability  of  the  stockholders  to  the 
company  is  $20,000,  therefore  the  net  liability  of  the  com- 
pany to  the  stockholders  is  $120,000,  which  is  composed  of 
Jhe  two  items,  Capital  Stock,  $100,000;   Surplus,  $20,00(X/ 
The  bookkeeper  now  enters  the  assets  and  liabilities^wRTcn 
he  counted  from  the  first  position  and  the  net  liability  which 
he  counted  from  the  second  position,  and  of  course  his  state- 
ment balances. 

[  The^-acomntant  claims  that  he  has  demonstrated  the 
proposition  that  assets  and  liabilities  are  always  equal;  but, 
as  a  matter  of  fact,  he  has  demonstrated  nothing,  except  a 
grotesquelv  absurd  trick  in  the  use  of  words./  He  can  count 

w  —  i —  -         -  ___  — —    '—        .. —•    •      -•    ^ijt0~  «< 

assets  and  liabilities  equal,  but  in  orderto  do  it  he  must 
count  each  item  twice,  once  as  an  asset  and  once  as  a  liability, 
in  exactly  the  same  manner  as  in  our  illustration  B  counts 
three  men  on  each  side  by  counting  each  man  twice,  once 
on  the  right  and  once  on  the  left. 

In  doing  his  work  the  bookkeeper  follows  a  certain  routine 
and  does  not  consciously  go  through  the  performance 
described  above;  but  the  following  forms  will  show  that  if 


DOUBLE-ENTKY   BOOKKEEPING 


he  is  not  conscious  of  reversing  his   position  it  is   simply 
because  he  is  mentally  cross-eyed. 

I.     ORDINARY  FORM,  CROSS-EYED  BOOKKEEPING 


Assets 

Accounts   Receivable    .  $14,000 

Bills  Receivable 6,000 

Real    Estate    40,000 

Merchandise    120,000 

Cash    5,000 

Total  .  .$185,000 


Liabilities 

Capital  Stock   $100,000 

Surplus    35,000 

Accounts  Payable    ....     30,000 
Bills  Payable    20,000 

Total  $185,000 


II.     CORRECT    FORM,    STRAIGHT-EYED    BOOKKEEPING 


Assets 
Accounts  Receivable 
Bills   Receivable 

.  $14,000 
6  000 

Liabilities 
Accounts  Payable   .  . 
Bills  Payable    .  . 

..   $30,000 
20,000 

Real    Estate    

.  .     40  000 

Merchandise 

.     120,000 

Total        

$50,000 

Cash    

5,000 

Bal     (Net    Capital). 

.     135  000 

Total    . 

$185  000 

$185,000 

Bal.    (Net    Capital) 

$135  000 

Capital  Stock   

.  .$100000 

Surplus           

.  .     35,000 

$135,000 

$135,000 

In  the  first  case,  the  bookkeeper  imagines  himself  at  a 
standpoint  midway  between  the  stockholders  and  the  outside 
world — a  standpoint  from  which  he  can  look  in  both  direc- 
tions. When  he  says  that  the  item  under  the  head  of 
Accounts  Payable  is  a  liability,  he  must  be  looking  away  from 
the  stockholders,  he  means  liability  of  the  stockholders;  and 
when  he  says  that  the  item  under  the  head  of  Capital  Stock 
is  a  liability,  he  must  be  looking  toward  the  stockholders, 
he  means  liability  to  the  stockholders.  Since  he  says  that 
both  items  are  liabilities  at  the  same  time,  he  must  be  looking 
in  both  directions  at  the  same  time ;  in  other  words,  he  must 
be  cross-eyed. 

In  the  second  case  the  bookkeeper  imagines  himself  at  the 
standpoint  of  the  stockholders  and  always  looks  in  one  direc- 


26  PRINCIPLES    OF 

tion.  When  he  means  asset,  he  says  asset;  when  he  means 
liability,  he  says  liability ;  and  when  he  means  net  capital,  he 
says  net  capital. 

The  doctrine  of  equal  assets  and  liabilities  is  simply  a 
piece  of  verbal  jugglery  by  which  the  bookkeeper  tries  to 
deceive  himself  and  other  people  as  well,  and  it  owes  its 
success  to  the  fact  that  the  mind  easily  becomes  confused 
in  the  use  of  relative  termsj  Words  like  asset  and  liability, 
right  and  left,  etc.,  have  no  meaning  unless  used  from  a 
single  fixed  standpoint ;  to  use  them  from  the  standpoint  of 
a  party  that  faces  both  ways  is  to  use  words  without  sense. 
Whenever  a  person  makes  a  statement  involving  the  use  of 
such  words  from  a  double  standpoint  it  is  positive  proof 
either  of  mental  confusion  on  his  part  or  of  a  deliberate 
intent  to  confuse  the  minds  of  others.  ^f_the  reader  is  not 
ready  to  grant  the  truth  of  that  remark,  let  him  compare 
these  two  propositions :  j 

1.  In  double-entry  bookkeeping  the  total  of  the  assets 
and  the  total  of  the  liabilities  are  necessarily  equal,  because 
every  item  which  is  asset    of  the  business  looking  one  way  is 
liability  of  the  business  looking  the  other  way. 

2.  In  every  street  the  number  of  buildings  on  the  right- 
hand  side  and  the  number  of  buildings  on  the  left-hand  side 
are  necessarily  equal,  because  every  building  which  is  on  the 
right-hand  side  looking  one  way  is  on  the  left-hand  side 
looking  the  other  way. 

The  first  proposition  professes  to  make  a  distinction 
between  asset  and  liability  and  the  second  professes  to  make 
a  distinction  between  right  and  left,  but  in  each  case  it  is 
nothing  more  than  a  pretence;  from  the  standpoint  of  a 
party  that  faces  both  ways  the  distinction  is  obliterated. 

The  reason  why  the  accountant  has  resorted  to  the  use 
of  relative  terms  from  a  double  standpoint  is  obvious.  It  is 
because  he  has  never  been  able  to  solve  the  first  problem  in 
double-entry  bookkeeping,  the  problem  which  is  involved  in 


DOUBLE-ENTRY    BOOKKEEPING  27 

< 
j 

the  question  stated  in  Chapter  II,  namely,  Who  is  the  second   / 
party  in  the  proprietor's  account? 

When  the  accounts  are  closed  and  the  balances  are  brought 
down  to  new  account,  the  total  of  the  balances  brought  down 
as  debits  always  equals  the  total  of  the  balances  brought  down 
as  credits;  and  what  the  bookkeeper  calls  his  statement  of 
assets  and  liabilities  is  simply  a  tabulation  of  these  balances. 
Such  a  statement  almost  invariably  contains  three  classes  of 
items — items  representing  asset,  items  representing  liability 
and  items  representing  net  capital.  But  the  bookkeeper  has 
never  been  able  to  explain  why  it  is  that  in  some  accounts 
balances  brought  down  to  new  account  represent  assets  and 
liabilities,  while  in  other  accounts  such  balances  represent 
net  capital ;  and  because  he  cannot  explain  it,  he  tries  to  con- 
ceal his  ignorance  by  juggling  with  words.  But  that  subter- 
fuge does  not  help  the  matter;  it  leaves  it  just  where  it 
was  before. 

In  corporation  accounting  the  bookkeeper  thinks  that  the 
company  is  an  intermediate  party  standing  between  the  stock- 
holders and  the  outside  world  (an  idea,  by  the  way,  which  is 
entirely  wrong),  and  he  professes  to  justify  his  failure  to " 
separate  items  which  represent  net  capital  from  those  which 
represent  liability,  by_sajing  that^thej^alLx^^6-5^  liability 
from  the  standpoint^  the  Company.  Granting,  for  the  sake 
of  the  aTgmn^n^TKat  his  conception  of  a  company  is  correct, 
he  still  must  admit  that  his  statement  contains  items  repre- 
senting asset  of  the  company,  items  representing  liability 
of  the  company  to  the  public,  and  items  representing 
liability  of  the  company  to  the  stockholders.  What  does 
the  bookkeeper  think  that  he  gains,  when,  instead  of 
using  clear  and  definite  terms,  he  resorts  to  the  use  of 
clumsy  and  inaccurate  circumlocutions;  when,  instead  of 
saying  that  the  items  represent  asset,  liability  and  net  capital, 
he  says  that  they  represent  one  kind  of  asset  and  two  kinds 
of  liability?  In  any  case,  the  fact  remains  that  there  are 


28  PRINCIPLES    OF 

three  classes  of  items,,  and  therefore  the  practice  of  making 
the  statement  in  a  form  which  would  indicate  that  it  contains 
but  two  classes  of  items  is  false  and  misleading. 

\A11  persons  of  normal  mind,  except  accountants,  instinc- 
tively recognize  that  fact;  and  even  some  accountants  go  so 
far  as  to  admit  it,  and  propose  to  remedy  the  matter  by 
fthe  headings./In  current  practice  it  is 


_^ 

customary  to  head  one~side  of  the  statement  with  the  word 
"Assets"  or  "Resources,"  and  the  other  side  with  the  word 
"Liabilities";  and  they  propose  to  change  the  latter  heading 
to  "Capital  and  Liabilities/^/  But  that  again,  is  simply  to 
juggle  with  words.  To  head  a  list  of  items  with  the  legend 
"Capital  and  Liabilities"  is  about  as  satisfactory  as  it  would 
be  to  put  up  a  sign-board  at  a  place  where  the  road  forks, 
saying,  "These  roads  lead  to  Duxbury  and  Eoxbury."  The 
travelers  who  read  the  sign-board  do  not  want  to  know  that 
the  roads  lead  to  Duxbury  and  Roxbury;  they  want  to  know 
which  road  leads  to  Duxbury  and  which  road  leads  to  Rox- 
bury. In  like  manner,  the  stockholders  of  a  company  do 
not  want  to  know  that  a  certain  list  contains  items  represent- 
ing net  capital  and  items  representing  liability;  they  want 
to  know  which  items  represent  net  capital  and  which  items 
represent  liability,  j 

Of  course  the  accountant  may  argue  that  the  stockholders 
are  supposed  to  be  able  to  separate  the  items.  But  if  the 
stockholders  can  separate  them,  why  does  he  not  do  it  him- 
self? If  his  report  never  contained  any  items  representing 
net  capital  except  Capital  Stock  and  Surplus,  possibly  the 
stockholders  could  separate  them  ;  but  in  his  statement,  under 
the  head  of  "Liabilities,"  they  often  find  items  like  "Sinking 
Fund,"  for  example.  Does  that  item  represent  a  liability, 
or  does  it  represent  a  portion  of  the  net  capital  which  is 
supposed  to  be  reserved  for  a  certain  reason?  Are  the  bonds 
a  liability  and  the  sinking  fund  also  a  liability?  Are  lia- 
bilities to  be  counted  twice?  If  the  accountant  does  not 


DOUBLE-EN  THY   BOOKKEEPING  29 

know  how  to  answer  such  questions,  how  can  he  expect  the 
stockholders  to  know  ? 

The  bookkeeper  is  at  fault  in  that  he  fails  to  separate 
items  which  represent  net  capital  from  those  which  repre- 
sent liability,  and  as  long  as  he  fails  to  make  that  separation 
it  is  idle  for  him  to  claim  that  he  knows  what  his  accounts 
mean.  He  may  plead  the  sanction  of  universal  custom,  or 
he  may  offer  any  other  excuse  which  his  ingenuity  can  devise, 
but  he  will  never  be  able  to  make  people  believe  that  a  man 
who  has  an  intelligent  idea  as  to  what  he  is  doing  and  why 
he  does  it,  would  ever  place  items  of  such  divergent  nature 
under  the  same  heading. 

In  all  languages  except  English  it  is  customary  to  head 
one  side  of  the  statement  with  the  word  "Active/'  and  the 
other  side  with  the  word  "Passive."  This  custom  has  its 
origin  in  the  fact  that  a  debit  entry  in  a  ledger  account  means 
that  the  party  owes,  it  corresponds  to  the  active  form  of  the 
verb,  and  a  credit  entry  means  that  the  party  is  owed,  it 
corresponds  to  the  passive  form. 

But  whether  the  bookkeeper  uses  the  headings  "Assets" 
and  "Liabilities/5  or  the  headings  ''Assets"  and  "Capital  and 
Liabilities,"  or  the  headings  "Active"  and  "Passive,"  is  a 
matter  of  little  consequence.  Whatever  headings  are  used, 
a  form  of  statement  in  which  all  debit  balances  are  placed  on 
the  one  side  and  all  credit  balances  on  the  other,  without 
discrimination,  is  illogical  and  unintelligible.  If  double- 
entry  bookkeeping  involves  the  necessity  of  making  statements 
in  that  form,  it  is  not  a  rational  system  of  accounting. 

The  object  of  this  treatise  is  to  prove  that  double-entry 
bookkeeping  is  a  rational  process,  that  it  counts  assets  and 
liabilities  from  the  natural  standpoint,  the  standpoint  of  the 
proprietor  (or  the  proprietors  collectively),  and  that  every 
bookkeeper  who  prefers  the  guidance  of  reason  to  that  of 
custom  and  tradition  will  always  make  his  statements  in  a 
form  showing  assets,  liabilities  and  net  capital  separately. 


30  •      PRINCIPLES    OF 


CHAPTER   IV 

DISCUSSION     OF     THE    TECHNICAL    TERMS    AND    THE     FUNDA- 
MENTAL  RELATIONS    OF   ACCOUNTING. 

The  words  which  express  the  basic  conceptions  with  which 
bookkeeping  deals,  namely,  asset,  liability,  loss  and  gain, 
flT^jrpla/hivfl^jgrTTi^  an  ^therefore  it  js_necesgary._tQ.  specify 
the  standpoint  from  which  they  are  used.  In  other  words,  it 
is  necessary  to  have  a  clear  understanding  as  to  whose  assets 
and  liabilities  and  losses  and  gains  we  are  talking  about. 

It  is  an  evident  fact  that  any  person's  assets  and  liabilities, 
as  well  as  his  losses  and  gains,  are  almost  invariably  unequal, 
and  in  single-entry  bookkeeping  that  fact  is  accepted  without 
any  question.  But  the  failure  to  understand  the  principles 
of  double-entry  bookkeeping  has  given  rise  to  the  idea  that 
in  that  system  of  accounting  the  words  asset  and  liability 
cannot  be  used  from  the  standpoint  of  a  real  person  nor  from 
the  standpoint  of  a  number  of  real  persons  taken  collectively, 
but  that  they  must  be  used  from  the  standpoint  of  an  imagin- 
ary intermediate  party,  and  therefore  assets  and  liabilities 
are  always  equal.  In  the  case  of  an  individual  proprietor 
the  bookkeeper  thinks  that  the  intermediate  party  is  the 
"business,"  in  partnership  accounting  he  thinks  that  it  is 
the  firm,  and  in  corporation  accounting  he  thinks  that  it 
is  the  company. 

That  idea  is  entirely  wrongj  there_js_  no  intermediate 
party.  In  double-entry'bookkeeping,  as  in  any  other  proper 
system  of  accounting,  the  words  asset  and  liability,  like  the 
words  loss  and  gain,  must  be  used  from  the  standpoint  of 
the  proprietor  or  the  proprietors  collectively. 

Both  in  law  and  in  bookkeeping,  a  company  is  a  fictitious 
or  imaginary  person;  but  it  is  not  an  imaginary  person 
separate  from  the  stockholders,  it  is  an  imaginary  person  com- 


DOUBLE-ENTBY   BOOKKEEPING  31 

posed  of  the  stockholders,  and  a  firm  is  an  imaginary  person 
composed  of  the  various  partners.  In  other  words,  a  firm  or 
a  company  is  an  imaginary  composite  person,  as  distinguished 
from  an  actual  individual  person.  The  idea  that  a  firm  or  a 
company  is  an  imaginary  person  standing  apart  from  the 
real  persons  who  compose  the  organization  and  between  them 
and  the  outside  world,  is  an  utter  absurdity ;  a  firm  or  a  com- 
pany is  merely  an  association  of  individuals — apart  from  the 
persons  who  compose  it,  it  has  no  existence.  We  cannot 
separate  a  firm  from  its  members  nor  a  company  from  its 
stockholders;  the  members  are  the  firm  and  the  stockholders 
are  the  company.  The  words  firm  and  company  are  simply 
what  the  grammarians  call  "collective  nouns,"  the  one  mean- 
ing the  partners  collectively  and  the  other  meaning  the 
stockholders  collectively. 

When  speaking  of  losses  and  gains  the  bookkeeper  always 
uses  the  words  firm  and  company  in  their  proper  sense. 
When  he  says  that  the  firm  or  the  company  made  a  profit  of 
$20,000  during  the  year,  he  means  that  the  partners  col- 
lectively or  the  stockholders  collectively  made  a  profit  of 
$20,000.  Therefore,  in  order  to  have  a  correct  conception  of 
the  nature  of  a  business  organization,  all  that  the  reader  needs 
is  to  keep  in  mind  the  fact  that  when  speaking  of  assets  and 
liabilities  he  should  use  the  words  firm  and  company  in  the 
same  sense  in  which  he  uses  them  when  speaking  of  losses 
and  gains.  In  this  treatise,  then,  when  we  speak  of  the 
assets  and  liabilities  of  a  firm  we  mean  the  assets  and  lia- 
bilities of  the  partners  collectively,  and  when  we  speak  of  the 
assets  and  liabilities  of  a  company,  we  mean  the  assets  and 
liabilities  of  the  stockholders  collectively. 

As  a  rule,  the  books  do  not  cover  all  the  affairs  of  the 
person  or  persons  who  own  the  business.  In  the  case  of  a 
firm  or  a  company,  it  is  evident  that  the  bookkeeper  has 
nothing  to  do  with  the  private  affairs  of  the  partners  or 
stockholders;  and  even  when  the  owner  is  an  individual,  he 


32  PRINCIPLES    OF 

usually  makes  a  distinction  between  his  personal  affairs  and 
his  business  affairs,  and  the  bookkeeper  is  concerned  only 
with  the  latter.  It  is,  therefore,  necessary  to  specify  further 
that  whenever  the  words  asset,  liability,  loss  and  gain  are 
used  in  this  treatise,  they  refer  to  that  portion,  and  only  to 
that  portion,  of  the  proprietor's  assets  and  liabilities  and 
losses  and  gains  which  pertains  to  the  business  whose  accounts 
we  are  keeping. 

It  will  be  noted  that  in  speaking  of  the  proprietor's  assets 
and  liabilities  which  pertain  to  the  business,  we  are  not  per- 
sonifying the  business;  we  are  not  using  the  words  asset  and 
liability  from  the  standpoint  of  the  business,  but  from  the 
standpoint  of  the  proprietor.  In  the  case  of  an  individual 
proprietor,  the  words  are  used  from  the  standpoint  of  that 
individual;  in  the  case  of  a  firm,  they  are  used  from  the 
standpoint  of  the  partners  collectively;  and  in  the  case  of 
a  company,  they  are  used  from  the  standpoint  of  the  stock- 
holders collectively.  In  all  three  cases,  assets  and  liabilities, 
like  losses  and  gains,  are  almost  invariably  unequal. 

I  have  been  thus  particular  in  specifying  the  standpoint 
from  which  relative  terms  are  used  in  accounting,  because 
otherwise  it  would  be  impossible  to  discuss  the  subject  of 
double-entry  bookkeeping  coherently;  and  moreover,  it  is 
right  here  that  the  ordinary  text-books  beg  the  question. 
Among  the  text-books  which  accept  the  doctrine  of  equal 
assets  and  liabilities,  I  have  never  seen  one  in  which  the 
author  gives  any  definite  information  as  to  whose  assets  and 
liabilities  and  losses  and  gains  he  is  talking  about.  When 
he  speaks  of  property  belonging  to  the  proprietor  as  repre- 
senting asset,  and  of  debts  owed  by  the  proprietor  as  repre- 
senting liability,  one  naturally  supposes  that  he  is  talking 
about  the  assets  and  liabilities  of  the  proprietor.  Finally, 
however,  he  makes  a  statement  showing  assets  and  liabilities 
equal,  and  then,  if  he  thinks  it  worth  while  to  s"ay  anything 


DOUBLE-ENTKY   BOOKKEEPING  33 

at  all,  he  says  that  the  statement  shows  the  assets  and  lia- 
bilities of  the  "business." 

^-But  he  also  makes  another  statement,  showing  losses  and 
gains  unequal,  and  therefore  it  is  evident  that  although  he 
professes  to  be  dealing  with  the  assets  and  liabilities  of  the 
business,  he  is  dealing  with  the  losses  and  gains  of  the  pro- 
prietor. Now,  losses  and  gains  are  simply  changes  in  assets 
and  liabilities,  and  the  question  as  to  how  he  can  count 
assets  and  liabilities  from  one  standpoint  and  losses  and  gains 
from  another,  how  he  can  count  assets  and  liabilities  from  a 
standpoint  which  makes  them  equal  and  losses  and  gains  from 
a  standpoint  which  makes  them  unequal,  is  a  subject  on  which 
he  is  most  discreetly  silent. 

The  distinction  between  the  owner's  persong.1_Rffg im ^jgnj 
his  business  affairs  gives  rise  to  the  idea  of  putting  capita], 
jntojjie  businjssjmp^jjfj^ 

When  TiKeTowner  puts  capital  into  the  business  the  operation 
is  called  a  contribution;  when  the  owner  draws  capital  out 
of  the  business  the  operation  is  called  a  withdrawal;  every  ' 
other  operation  involving  income  or  outgo  or  both  is  called 
a  transaction.  / 

The-j&rds  income  and  outgo,  as  used  in  bookkeeping, 
are  similar  to  the  words  gain  and  Zo££2_butJtheyJiave  a  broader ., 
meaning.  When  the  owner  contributes  capital  there  is 
income  (increase  of  asset  pertaining  to  the  business),  but  this 
income  is  not  gain;  when  the  owner  withdraws  capital  there 
is  outgo  (decrease  of  asset  pertaining  to  the  business),  but  this 
outgo  is  not  loss;  in  every  other  case  income  is  gain  and 
outgo  is  loss.  Income  and  outgo,  then,  are  changes  in  assets 
and  liabilities,  inclusive  of  changes  due  to  contributions  and 
withdrawals ;  gains  and  losses  are  changes  in  assets  and  lia- 
bilities, exclusive  of  changes  due  to  contributions  and  with- 
drawals. 

It  will  be  noted  that  according  to  the  above  definition 


34  PRINCIPLES    OF 

the  word  loss  (and  therefore  its  opposite,  gain)  has  a  wider 
meaning  in  bookkeeping  than  in  ordinary  language.  Ordi- 
narily, the  use  of  the  word  loss  is  confined  to  cases  which 
involve  an  idea  of  waste,  but  in  bookkeeping  it  is  not  limited 
to  such  cases.  For  example,  the  consumption  of  fuel  for  a 
useful  purpose  would  not  be  called  loss  in  the  ordinary  sense 
of  ,the  word,  but  in  bookkeeping  it  is  regarded  as  loss.  Apart 
from  contributions  and  withdrawals,  every  decrease  of  asset 
or  increase  of  liability  is  loss,  and  every  increase  of  asset  or 
decrease  of  liability  is  gain. 

An  asset  is  a  financial  resource — it  may  be  a  debt  owed 
to  the  proprietor  or  it  may  be  anything  owned  by  the  pro- 
prietor, the  value  of  which  can  be  expressed  in  terms  of 
money — and  a  liability  is  an  obligation  to  pay  for  something 
which  has  already  been  received.  A  contract  to  buy  a  cer- 
tain thing  at  a  certain  price  at  some  future  date  is  an  obli- 
gation to  pay;  but  it  is  not  a  liability,  in  the  bookkeeping 
sense,  because  the  thing  for  which  payment  is  to  be  made 
has  not  yet  been  received.  As  long  as  the  thing  to  be  paid 
for  cannot  be  counted  as  an  asset,  the  obligation  to  pay  for 
it  cannot  be  counted  as  a  liability.  An  agreement  to  pay 
a  certain  sum  in  the  course  of  a  year  for  the  rent  of  a  building 
is  an  obligation  to  pay;  but  it  is  not  a  liability,  because  the 
tenant  has  not  yet  had  the  use  of  the  building.  The  tenant's 
liability  at  any  given  time  is  determined  by  the  amount  of 
unpaid  rent  which  has  accrued  to  date.  If  the  tenant  pays 
rent  in  advance,  then,  at  any  given  time,  the  amount  of  rent 
prepaid  is  an  asset  from  the  standpoint  of  the  tenant  and 
a  liability  from  the  standpoint  of  the  landlord.  When  money 
is  borrowed  to  be  repaid  at  some  future  date  with  interest, 
the  principal  is  a  liability,  because  that  amount  has  been 
received;  but  the  interest  becomes  a  liability  only  as  it 
accrues.  When  a  bank  discounts  a  note,  that  is  to  say, 
deducts  the  amount  of  the  interest  and  gives  the  remainder 


DOUBLE-ENTKY   BOOKKEEPING  35 

to  the  borrower,  the  prepaid  interest  is  an  asset  from  the 
standpoint  of  the  borrower  and  a  liability  from  the  standpoint 
of  the  bank. 

The  meaning  of  the  words  asset  and  liability,  as  used  in 
bookkeeping,  differs  somewhat  from  the  common  usage.  This 
difference  is  due  to  the  fact  that  while  in  ordinary  language 
the  words  are  of  nearly  opposite  meaning,  in  bookkeeping 
they  are  exact  opposites.  In  double-entry  bookkeeping  the 
words  asset  and  liability  must  necessarily  be  used  as  exact 
opposites,  because  the  system  is  based  upon  the  use  of  the 
words  debtor  and  creditor,  which  are  exact  opposites.  It  is, 
therefore,  impossible  to  convey  the  precise  meaning  of  the 
words  asset  and  liability  by  defining  each  of  them  separately. 
The  only  way  to  give  the  correct  meaning  of  the  words  is  to 
define  each  of  them  as  nearly  as  possible,  and  then  to  add : 
Whatever  meaning  the  word  asset  may  have,  the  word  liability 
has  the  opposite  meaning;  whatever  meaning  the  word  lia- 
bility may  have,  the  word  asset  has  the  opposite  meaning. 
If  merchandise  bought  is  an  asset,  merchandise  sold  is  a 
liability;  if  cash  received  is  an  asset,  cash  paid  out  is  a 
liability.  Anything  which  offsets  an  asset  is  a  liability; 
anything  which  offsets  a  liability  is  an  asset. 

The  fact  that,  as  a  rule,  the  proprietor  has  certain  lia- 
bilities as  well  as  certain  assets  gives  rise  to  the  idea  of  net 
capital.  In  arithmetical  language  the  net  capital  is  the 
difference  between  the  assets  and  the  liabilities ;  in  algebraical 
language  it  is  the  sum  of  the  assets  and  the  liabilities.  Most 
writers  use  the  term  net  capital  only  when  the  assets  exceed 
the  liabilities;  when  the  liabilities  exceed  the  assets,  they 
call  the  difference  the  net  insolvency.  But  when  used  in  its 
proper  sense  there  is  no  such  limitation  to  the  meaning  of  the 
term  net  capital.  In  mathematical  language,  the  result 
obtained  by  subtracting  the  total  of  the  liabilities  from  the 
of  the  assets  is  the  net  capital,  no  matter  whether  the 


36  PRINCIPLES    OF 

result  be  positive,  negative  or  zero.  In  bookkeeping  language, 
the  balance  of  the  proprietor's  account  is  the  net  capital,  no 
matter  whether  it  be  brought  down  as  a  credit  or  as  a  debit 
or  whether  it  be  zero.  When  the  assets  exceed  the  liabilities, 
the  excess  is  the  net  asset;  when  the  liabilities  exceed  the 
assets,  the  excess  is  the  net  liability.  Net  asset  is  positive 
net  capital ;  net  liability  is  negative  net  capital.  It  should  be 
noted,  however,  that  in  bookkeeping  the  distinction  between 
positive  and  negative  net  capital  is  not  indicated  by  the  use 
of  those  words,  nor  by  the  use  of  the  signs  "+"  and  " — " 
but  by  the  fact  that  in  the  one  case  the  balance  of  the  pro- 
prietor's account  is  brought  down  as  a  credit  and  in  the 
other  case  as  a  debit.  It  should  be  noted,  also,  that  usually, 
when  we  speak  of  net  capital,  we  mean  positive  net  capital, 
since  under  normal  conditions  the  net  capital  is  positive, 
that  is  to  say,  the  assets  exceed  the  liabilities.  When  we  wish 
to  indicate  negative  net  capital,  as  distinguished  from  positive 
net  capital,  we  call  it  the  net  liability.  But,  nevertheless,  the 
term  net  capital  when  used  in  its  full  sense  includes  both 
positive  and  negative  net  capital. 

The  effect  of  the  algebraical  term  negative  is  to  reverse 
the  sense  in  which  expressions  are  used.  When  a  positive 
quantity  becomes  smaller  we  say  that  it  decreases,  but  when 
a  negative  quantity  becomes  smaller  we  say  that  it  increases. 
If,  for  example,  we  use  the  term  net  liability  and  assume 
that  it  was  $20,000  and  is  now  $10,000,  we  say  that  the  net 
liability  has  decreased.  But  if  we  use  the  term  net  capital 
and  assume  that  it  was  —$20,000  and  is  now  —$10,000,  we 
say  that  the  net  capital  has  increased.  Every  change  in  the 
net  capital  which  is  favorable  to  the  proprietor  is  an  increase 
or  gain,  and  every  change  which  is  unfavorable  to  the  pro- 
prietor is  a  decrease  or  loss,  no  matter  whether  the  net  capital 
be  positive  or  negative. 

The  advantage  of  having  a  term  which  can  be  used  both 
in  the  positive  and  in  the  negative  sense  is  that  it  gives  us  a 


DOUBLE-ENTRY    BOOKKEEPING  37 

'  more  compact  form  of  expression.  If  we  had  only  the  terms 
net  asset  and  net  liability,  or  if  we  used  net  capital  to  mean 
net  asset  and  net  insolvency  to  mean  net  liability,  we  would 
often  have  to  explain  general  propositions  three  times,  once 
on  the  assumption  that  the  assets  exceed  the  liabilities.,  again 
on  the  assumption  that  the  liabilities  exceed  the  assets,  and 
again  on  the  assumption  that  the  assets  and  liabilities  are 
_equal,  since  the  wording  would  differ  in  the  various  cases. 
But  if  we  use  the  term  net  capital  to  mean  net  asset  when 
positive  and  net  liability  when  negative,  one  explanation  is 
sufficient.  The  principles  which  apply  to  any  given  case  are 
independent  of  the  amount  of  the  net  capital,  whether  it  be 
large  or  small,  whether  it  be  positive,  negative  or  zero. 

In  this  discussion  it  is  necessary  to  keep  clearly  in  mind 
the  difference  between  arithmetical  language  and  algebraical 
language.  Arithmetic  uses  the  signs  "-{-"  and  " — "  only 
to  indicate  addition  and  subtraction,  it  does  not  recognize 
the  algebraical  distinction  between  positive  and  negative; 
it  deals  only  with  positive  quantities.  In  arithmetic  the 
difference  between  two  quantities  is  the  result  obtained  by 
subtracting  the  smaller  from  the  greater;  in  algebra  the 
difference  between  two  quantities  is  the  result  obtained  by 
subtracting  the  second  one  from  the  first.  In  arithmetic  the 
difference  between  7  and  3  is  4,  and  the  difference  between 
3  and  7  is  4  (7  —  3  =  4) ;  in  algebra  the  difference  between 
7  and  3  is  4  (7  —  3  =  4),  and  the  difference  between  3  and 
7  is  — 4  (3  —  7  =  —  4). 

In  arithmetical  language  both  assets  and  liabilities  are 
positive,  but  in  algebraical  language  liabilities  are  simply 
negative  assets.  The  result  is  that  in  using  the  terms  sum 
and  difference  as  applied  to  assets  and]  liabilities,  algebraical 
language  is  just  the  reverse  of  arithmetical  language.  If, 
in  a  given  case,  the  total  of  the  assets  is  $40,000  and  the 
total  of  the  liabilities  is  $10,000,  then,  in  arithmetical  lan- 
guage the  sum  of  the  two  is  $50,000  (40,000  +  10,000  = 


38  PRINCIPLES    OF 

50,000),  and  the  difference  between  the  two  is  $30,000 
(40,000  --  10,000  =  30,000);  but  in  algebraical  language 
the  sum  of  the  two  is  $30,000  [40,000  +  (—  10,000)  = 
30,000],  and  the  difference  between  the  two  is  $50,000 
[40,000  —  (—  10,000)  =  50,000]. 

In  algebraical  language  the  relations  which  assets,  lia- 
bilities, income,  outgo,  gains,  losses,  contributions,  with- 
drawals and  net  capital  bear  to  each  other  may  be  expressed 
as  follows : 

The  sum  of  the  assets  (and  liabilities)  at  any  given  time 
is  the  net  capital  at  that  time. 

The  difference  between  the  net  capital  at  the  end  of  a 
period  and  the  net  capital  at  the  beginning  is  the  net  income 
(or  outgo)  during  the  period. 

The  difference  between  the  net  income  (or  outgo)  and  the 
net  amount  contributed  (or  withdrawn)  is  the  net  gain  (or 
loss). 

In  strict  usage  of  algebraical  language  the  words  in 
parentheses  would  be  omitted,  since  a  liability  is  simply  a 
negative  asset,  outgo  is  negative  income,  a  withdrawal  is  a 
negative  contribution,  and  loss  is  negative  gain. 

If  anyone  should  try  to  state  the  above  relations  in 
arithmetical  language,  he  would  find  that  there  are  a  great 
many  possible  cases  (assets  greater  than  liabilities,  assets  less 
than  liabilities,  assets  and  liabilities  equal,  net  capital  at 
close  greater  than  at  beginning,  net  capital  at  close  less  than 
at  beginning,  etc.,  etc.),  and  he  would  have  to  make  a 
separate  statement  for  each  case;  but  when  algebraical  lan- 
guage is  used,  the  one  statement  covers  every  possible  case. 
Algebraical  language  bears  the  same  relation  to  arithmetical 
language  that  the  language  of  double-entry  bookkeeping 
bears  to  the  language  of  single-entry  bookkeeping — it  is  more 
compact, 


DOUBLE-ENTRY    BOOKKEEPING  39 


CHAPTER   V 

DEBTS — THE  ACCRUING  AND  MATURING  OF  DEBTS DEBTS   ARE 

RECORDED  AS  IF  PAYABLE  ON  DEMAND — GOOD  DEBTS  ARE 
ASSETS  AND  LIABILITIES,  BAD  DEBTS  REPRESENT  LOSSES 
AND  GAINS — THE  WORDS  "GOOD"  AND  "BAD"  AS  APPLIED 
TO  DEBTS  ARE  NOT  OPPOSITES. 

At  first  thought  one  might  have  the  impression  that  a  debt 
owed  to  the  proprietor  is  always  an  asset  and  that  a  debt 
owed  by  the  proprietor  is  always  a  liability.  But  it  is  evident 
that  a  debt  owed  to  the  proprietor  is  not  an  asset  unless  it 
will  be  paid;  and,  therefore,  if  the  words  asset  and  liability 
are  exact  opposites,  a  debt  owed  by  the  proprietor  is  not  a 
liability  unless  it  will  be  paid. 

When  we  think  that  a  debt  will  be  paid,  we  call  it  "good" ; 
when  we  think  that  a  debt  will  not  be  paid,  we  call  it  "bad." 

A  debt,  then,  can  be  counted  as  an  asset  or  as  a  liability 
only  on  the  assumption  that  it  is  good,  that  is  to  say,  that  it 
will  be  paid;  assuming  that  it  will  be  paid  only  in  part,  it 
can  be  counted  as  an  asset  or  as  a  liability  only  to  that  extent. 

There  is,  however,  a  distinction  to  be  made  between  debts 
owed  to  the  proprietor  and  debts  owed  by  the  proprietor. 
The  books  are  kept  on  the  assumption  that  all  lawful  debts 
owed  by  the  proprietor  will  be  paid ;  whereas,  some  of  the  law- 
ful debts  owed  to  the  proprietor  may  not  be  paid.  In  other 
words,  lawful  debts  owed  by  the  proprietor  are  liabilities, 
but  lawful  debts  owed  to  the  proprietor  are  not  necessarily 
assets.  This  distinction  must  be  made  because  lawful  debts 
owed  by  the  proprietor,  no  matter  whether  they  will  be  paid 
or  not,  are  liabilities  in  the  legal  sense  of  the  term,  and  the 
only  way  to  bring  the  bookkeeping  definition  into  harmony 
with  the  legal  definition  is  to  assume  that  all  such  debts  will 
be  paid.  That  assumption  is  a  natural  one,  because  as  long 
as  a  man  continues  in  business  he  must  at  least  pretend  that 


40  PRINCIPLES    OF  \ 

his  lawful  debts  will  be  paid;  to  admit  th^t  they  will  nc/t  be 
paid  is  to  admit  that  he  is  bankrupt.  x^But  only  lawful,  or  I  , 
real,  debts  owed  by  the  proprietor-afe  necessarily  liabilities;^!  1 
in  double-entry  bookkeeping  we  deal  with  imaginary  as  well  . 
as  real  debts,  therefore  there  may  be  debts  owed  by  the  pro- 
prietor which  are  not  liabilities. 

In  discussing  the  subject  of  accounting  we  often  have 
occasion  to  speak  of  the  accruing  of  debts.  In  ordinary  lan- 
guage to  accrue  means  to  happen  or  result  as  a  natural 
growth,  it  conveys  an  idea  of  addition  or  increment;  but  as 
used  in  bookkeeping,  it  means  simply  to  come  into  existence. 
Some  debts  accrue  all  at  once,  and  others  are  accruing  all 
the  time.  Wrhen  money  is  loaned  at  interest  the  debt,  in  the 
case  of  the  principal,  accrues  at  the  time  of  making  the  loan, 
while  it  does  not  mature  until  the  date  fixed  for  payment; 
but  in  the  case  of  the  interest,  the  debt  accrues  with  the  lapse 
of  time,  and  matures  at  certain  fixed  dates. 

There  is,  then,  a  distinction  between  the  accruing  of  a 
debt  and  the  maturing  of  a  debt;  but  the  ledger  form  is  not 
adapted  to  the  expression  of  that  distinction.  The  ledger 
entry  shows  when  the  debt  accrues,  or  the  amount  which  has 
accrued  to  date,  but  there  is  nothing  to  indicate  when  the  debt 
matures.  It  follows,  therefore,  that  we  must  keep  the  books  on 
the  assumption  that  a  debt  matures  as  soon  as  it  accrues,  that 
all  debts  are  payable  on  demand.  A  debt  due  at  some  future 
date  may  be  perfectly  good,  yet  if  it  does  not  draw  the  current 
rate  of  interest  its  present  value  differs  from  its  face  value  to 
the  extent  of  the  interest  involved.  If  it  draws  more  than  the 
current  rate  of  interest,  its  present  value  is  greater  than  its 
face  value;  if  it  draws  less  than  the  current  rate,  its  present 
value  is  less  than  its  face  value.  When  the  fact  that  a  debt  is 
not  payable  on  demand  causes  its  present  value  to  differ  from 
its  face  value,  the  difference  (the  premium  or  discount)  is 
carried  as  an  asset  or  as  a  liability  under  a  separate  heading. 


DOUBLE-ENTBY    BOOKKEEPING  41 

In  other  words,  we  use  two  debts  payable  on  demand  to  repre- 
sent the  present  value  of  a  debt  due  at  some  future  date. 

The  fact  that  all  debts  are  recorded  as  if  payable  on 
demand  is  the  origin  of  one  of  the  fundamental  conceptions 
of  accounting,  namely,  that  all  good  debts  are  present  assets 
and  liabilities.  A  good  debt  owed  by  us  is  a  liability  by 
definition,  and  if  regarded  as  payable  on  demand,  it  is  a 
present  liability;  and  a  good  debt  owed  to  us,  if  regarded  as 
payable  on  demand,  is  a  present  asset,  since  a  good  debt 
payable  to  us  on  demand  is  practically  the  same  thing  as 
cash  in  hand. 

The  assumption  that  all  debts  are  payable  on  demand 
carries  with  it  the  assumption  that  all  debts  are  good  at  the 
time  when  they  are  contracted.  If  we  lend  money  to  any 
person  and  the  debt  is  payable  on  demand,  then,  if  we  demand 
immediate  payment  the  debt  is  good,  because  he  has  the  money 
with  which  to  pay  it.  Later,  however,  he  may  not  have  the 
money  and  the  debt  may  become  bad.  If  a  debt  which  was 
good  at  the  time  when  it  was  contracted  is  now  wholly  or 
partially  bad,  it  has  changed  in  value,  and  that  change  is 
loss  or  gain. 

Good  debts  are  assets  and  liabilities;  bad  debts  are  not 
losses  and  gains,  but  they  indicate  that  losses  and  gains  have 
occurred.  If  any  person  owes  a  debt  to  us  it  is  because  we 
have  lent  an  equivalent  amount  to  him.  If,  now,  he  will  not 
pay  the  debt,  if  the  debt  is  bad,  we  lose  what  we  lent  to  him; 
therefore  a  bad  debt  owed  to  us  represents  loss.  If  we  owe  a 
debt  to  any  person  it  is  because  we  have  borrowed  an  equiva- 
lent amount  from  him.  If,  now,  we  will  not  have  to  pay  the 
debt,  if  the  debt  is  bad,  we  gain  what  we  borrowed  from  him; 
therefore  a  bad  debt  owed  by  us  represents  gain. 

When  we  borrow  from  Cash  and  lend  to  Expense,  Expense 
owes  us  and  we  owe  Cash ;  we  debit  Expense  and  credit  Cash. 
The  debt  which  Expense  owes  to  us  is  bad,  it  represents 
loss;  the  debt  which  we  owe  to  Cash  is  good,  it  is  a  lia- 


42  PRINCIPLES    OF 

bility.  When  we  borrow  from  Interest  and  lend  to  Cash, 
Cash  owes  us  and  we  owe  Interest;  we  debit  Cash  and  credit 
Interest.  The  debt  which  Cash  owes  to  us  is  good,  it  is  an 
asset;  the  debt  which  we  owe  to  Interest  is  bad,  it  represents 
gain. 

An  imaginary  debt,  that  is  to  say,  a  debt  between  the 
proprietor  and  an  imaginary  person,  is  good  if  it  represents 
a  real  debt  which  is  good,  or  if  it  represents  a  tangible  asset 
or  an  offset  to  such  an  asset;  otherwise  it  is  bad.  A  debt 
between  the  proprietor  and  Expense  for  expenses  which  have 
accrued  and  have  not  been  paid  is  good,  because  it  represents 
a  real  debt.  Unpaid  expense  is  a  liability.  A  debt  between 
the  proprietor  and  Expense  for  expenses  which  have  accrued 
and  have  been  paid  is  bad,  because  the  real  debt  has  been 
paid.  Expenses  which  have  accrued  and  have  been  paid  repre- 
sent loss.  A  debt  between  the  proprietor  and  Expense  for 
expenses  which  have  been  paid  but  have  not  yet  accrued  is 
good,  because  there  is  a  real  debt  or  a  tangible  asset  cor- 
responding to  it.  Prepaid  expense  is  an  asset. 

As  an  example  to  illustrate  imaginary  debts  and  to  show 
how  they  may  change  in  value,  we  will  assume  that  at  the 
beginning  of  the  month  we  buy  $100  worth  of  coal  and  record 
the  transaction  by  debiting  Expense  and  crediting  Cash,  and 
that  at  the  end  of  the  month  we  have  three-quarters  of  the 
coal  left.  In  this  case  it  is  very  evident  that  the  debt  of  $100 
which  the  person  called  Expense  owes  us  was  perfectly  good 
at  the  time  when  it  was  recorded,  it  represented  an  asset  in 
the  form  of  coal;  but  now  at  the  end  of  the  month  the  debt 
is  good  to  the  amount  of  $75  and  bad  to  the  amount  of  $25. 
This  debt,  then,  which  did  represent  an  asset  of  $100,  now 
represents  an  asset  of  $75  and  a  loss  of  $25. 

Double-entry  bookkeeping  is  pre-eminently  the  science  of 
I  opposites.  It  is  based  upon  the  idea  of  owing  and  of  being 
j  owed,  upon  the  use  of  the  words  debtor  and  creditor,  which 


DOUBLE-ENTRY    BOOKKEEPING  43 

are  opposites.  The  words  asset  and  liability  are  opposites; 
the  words  income  and  outgo  are  opposites;  the  words  gain 
and  loss  are  opposites.  These  words  are  used  in  a  relative  j 
sense,  they  mean  asset  or  liability,  income  or  outgo,  gain  or 
loss,  from  the  standpoint  of  the  proprietor;  and  when  we 
say  that  they  are  opposites,  we  mean  that  they  are  opposites 
from  the  standpoint  of  the  proprietor. 

Two  equal  debts  which  are  opposites  from  the  standpoint 
of  the  proprietor  always  offset  each  other  if  they  are  good, 
but  they  do  not  necessarily  cancel  each  other;  they  cancel 
each  other  only  when  they  are  opposites  from  the  stand- 
points of  all  parties  concerned.  If  Smith  owes  the  pro- 
prietor $100  and  the  proprietor  owes  Jones  $100,  the  two 
debts  are  opposites  from  the  standpoint  of  the  proprietor, 
but  they  are  not  opposites  from  the  standpoints  of  Smith 
and  Jones,  and  therefore  they  do  not  cancel  each  other. 
But  if  Smith  owes  the  proprietor  $100  and  the  proprietor 
owes  Smith  $100,  the  two  debts  are  opposites  both  from  the 
standpoint  of  the  proprietor  and  from  the  standpoint  of 
Smith,  and  therefore  they  cancel  each  other. 

^But  while  the  words  asset  and  liability,  income  and  outgo, 
gain  and  loss,  are  used  in  a  relative  sense  and  are  opposites, 
the  words  good  and  bad,  as  applied  to  debts,  are  used  in  an 
absolute  sense  and  are  not  opposites.  If  these  words  were 
used  in  a  relative  sense,  if  they  meant  good  or  bad  from  the 
standpoint  of  the  proprietor,  then,  in  the  case  of  a  debt 
owed  to  the  proprietor,  if  we  thought  that  it  would  be  paid 
we  would  call  it  "good,"  and  if  we  thought  that  it  would  not 
be  paid  we  would  call  it  "bad";  whereas,  in  the  case  of  a 
debt  owed  by  the  proprietor,  if  we  thought  that  it  would 
have  to  be  paid  we  would  call  it  "bad,"  and  if  we  thought 
that  it  would  not  have  to  be  paid  we  would  call  it  "good." 
But  that  is  not  the  meaning  of  the  words  as  used  in  book- 
keeping./'' When  we  think  that  a  debt  will  be  paid,  whether 
owed'rothe  proprietor  or  by  the  proprietor,  we  call  it  "good"; 


44  PRINCIPLES    OF 

when  we  think  that  a  debt  will  not  be  paid,  whether  owed  to 
the  proprietor  or  by  the  proprietor,  we  call  it  "bad." 

It  is  evident  also  that  the  words  good  and  bad,  as  applied 
to  debts,  are  not  used  as  opposites.  If  Brown  owes  us  $100, 
then  to  say  that  the  debt  is  good  means  that  he  will  pay  us 
$100,  and  to  say  that  it  is  bad  means  that  he  will  not  pay  us 
anything;  therefore  if  the  debt  is  bad  we  lose  $100.  But  if 
the  words  good  and  bad  were  used  as  opposites,  then  to  say 
that  the  debt  is  good  would  mean  that  Brown  will  pay  us 
$100,  and  to  say  that  it  is  bad  would  mean  that  we  must  pay 
him  $100.  In  that  case,  if  the  debt  were  bad,  we  would  lose 
$200.  Bad  as  applied  to  debts  is  the  negation  of  good,  it  is 
not  the  opposite  of  good. 

The  distinction  between  one  expression  being  the  negation 
of  another  and  one  expression  being  the  opposite  of  another 
is  an  important  one  in  double-entry  bookkeeping;  but  it  is 
one  which  in  ordinary  language  and  in  ordinary  affairs  is 
rarely  brought  out.  The  following  propositions  will  make  the 
distinction  clear: 

1.     A  statement  and  its  negation  mutually  exclude  each 
other. 

For  example : 

The  debt  will  be  paid. 
The  debt  will  not  be  paid. 

Both  statements  cannot  be  true,  nor  can  both  be  false; 
to  the  extent  to  which  one  is  true  the  other  must  be  false, 
and  to  the  extent  to  which  one  is  false  the  other  must  be  true. 

2.  A  statement  and  its  opposite  do  not  necessarily  exclude 
each  other,  but  if  both  are  true  they  neutralize  each  other, 
and  the  effect  is  the  same  as  if  both  were  false. 

To  say  that  Smith  owes  Jones  $100  and  Jones  owes  Smith 
$100  is  equivalent  to  saying  that  neither  of  them  owes  any- 
thing to  the  other.  To  say  that  a  certain  transaction  involves 
equal  loss  and  gain  is  equivalent  to  saying  that  it  involves 


DOUBLE-ENTRY   BOOKKEEPING  45 

no  loss  nor  gain.  To  say  that  a  certain  item  is  both  an  asset 
and  a  liability  of  the  same  party  is  equivalent  to  saying  that 
it  is  neither  an  asset  nor  a  liability. 

The  reader  will  note  the  application  of  this  principle  to 
the  common  theory  of  double-entry  bookkeeping.  The  assets 
and  liabilities  of  the  "business"  are  necessarily  equal  only  on 
the  assumption  that  every  item  which  is  asset  or  liability  at 
all  is  both  an  asset  and  a  liability;  therefore  to  say  that  the 
assets  and  liabilities  of  the  business  are  necessarily  equal  is 
equivalent  to  saying  that  the  business  has  no  assets  and  no 
liabilities.  To  predicate  the  condition  of  necessary  equality 
is  to  wipe  out  the  idea  of  asset  and  liability  altogether. 

Asset  is  the  opposite  of  liability;  but  net  asset  is  not  the 
opposite  of  liability,  it  is  the  negation  of  liability.  To  deter- 
mine the  net  asset  we  exclude  all  of  the  liabilities  and  an 
equal  amount  of  the  assets,  and  what  remains  is  the  net  asset. 

Net  liability  is  not  the  opposite  of  asset,  it  is  the  negation 
of  asset.  To  determine  the  net  liability  we  exclude  all  of  the 
assets  and  an  equal  amount  of  the  liabilities,  and  what  remains 
is  the  net  liability. 

Gain  is  not  the  opposite  of  liability,  it  is  the  negation  of 
liability.  A  debt  owed  by  the  proprietor  to  an  outside  party 
must  represent  either  liability  or  gain;  to  deny  that  it  repre- 
sents liability  is  to  affirm  that  it  represents  gain. 

Loss  is  not  the  opposite  of  asset,  it  is  the  negation  of 
asset.  A  debt  owed  to  the  proprietor  by  an  outside  party 
must  represent  either  asset  or  loss ;  to  deny  that  it  represents 
asset  is  to  affirm  that  it  represents  loss. 

Net  asset  is  the  negation  of  all  liability;  gain  is  the 
negation  of  some  liability;  therefore  net  asset  includes  gain. 

Net  liability  is  the  negation  of  all  asset;  loss  is  the 
negation  of  some  asset;  therefore  net  liability  includes  loss. 

Gain  is  an  addition  to  the  net  asset  (or  a  deduction  from 


46  PRINCIPLES    OF 

the  net  liability) ;  loss  is  an  addition  to  the  net  liability  (or 
a  deduction  from  the  net  asset). 

The  difference  between  an  expression  and  its  opposite  is 
twice  as  great  as  the  difference  between  the  same  expression 
and  its  negation.  The  negation  of  having  an  asset  of  $100 
is  not  having  it,  and  the  difference  between  having  it  and  not 
having  it  is  $100.  But  the  opposite  of  having  an  asset  of 
$100  is  having  a  liability  of  $100,  and  the  difference  between 
having  an  asset  of  $100  and  having  a  liability  of  $100  is  $200. 

If  an  item  of  $100  is  counted  under  one  heading  when  it 
should  be  counted  under  the  opposite  heading,  the  amount 
of  the  error  is  $200;  but  if  the  item  is  counted  under  one 
heading  when  it  should  be  counted  under  the  negation  of  that 
heading,  the  amount  of  the  error  is  $100.  If  the  item  is 
counted  as  asset  when  it  should  be  counted  as  liability,  the 
amount  of  the  error  is  $200;  if  the  item  is  counted  as  gain 
when  it  should  be  counted  as  loss,  the  amount  of  the  error 
is  $200.  But  if  the  item  is  counted  as  asset  when  it  should 
be  counted  as  loss,  the  amount  of  the  error  is  $100;  if  the 
item  is  counted  as  liability  when  it  should  be  counted  as  net 
asset,  the  amount  of  the  error  is  $100. 


DOUBLE-ENTRY    BOOKKEEPING  47 

CHAPTEE    VI 

ABSTRACT    AND    CONCRETE    CONCEPTIONS. 

Double-entry  bookkeeping  is  based  upon  the  idea  of  debt 
and  that  idea  involves  the  person  who  owes,  the  thing  which 
is  owed,  and  the  person  to  whom  it  is  owed.  In  the  case  of 
good  debts  the  word  debt  may  be  used  both  in  the  abstract 
and  in  the  concrete  sense.  In  the  abstract  sense  it  means 
the  relation  between  the  two  persons,  the  state  of  owing  and 
of  being  owed ;  in  the  concrete  sense  it  means  the  thing  which 
is  owed.  ^In  the  case  of  bad  debts  the  word  debt  has  only 
an  abstract  meaning.  A  bad  debt  is  simply  a  relation  between 
two  persons;  there  is  nothing  concrete  about  it,  since  the 
thing  which  is  owed  fails  to  materialize. 

In  the  abstract  sense  the  words  asset  and  liability  express 
relations,  but  in  the  concrete  sense  they  mean  the  things 
which  are  related.  In  the  concrete  sense  an  asset  or  a  lia- 
bility is  a  certain  thing  in  a  certain  relation  to  a  certain 
person.  In  the  case  of  a  good  debt  the  thing  which  is  owed 
is  an  asset  from  the  standpoint  of  the  person  to  whom  it  is 
owed  and  a  liability  from  the  standpoint  of  the  person  who 
owes  it. 

In  the  abstract  sense  the  words  loss  and  gain  express 
changes,  but  in  the  concrete  sense  they  mean  the  things  which 
have  been  lost  or  gained.  When  we  speak  of  distributing 
profits  in  dividends,  we  are  using  the  word  profit,  or  gain, 
in  the  concrete  sense ;  we  mean  that  we  distribute  that  which 
has  been  gained. 

When  both  sets  of  words  are  used  in  the  concrete  sense, 
assets  and  liabilities  include  gains  and  losses,  since  a  thing 
which  has  been  gained  is  simply  a  new  asset,  and  a  thing 
which  has  been  lost  is  a  new  liability.     But  in  bookkeeping  J 
the  words  asset  and  liability  are  used  in  the  concrete  sense  j 
and  the  words  loss  and  gain  are  used  in  the  abstract  sense.       / 

The  words  asset  and  liability,  then,  express  concrete  con- 


48  PRINCIPLES    OF 

ceptions ;  the  words  loss  and  gain  express  abstract  conceptions. 
Assets  and  liabilities  are  things  which  exist;  losses  and  gains 
are  changes  which  occur.  We  speak  of  the  assets  and  lia- 
bilities which  exist  at  the  end  of  a  certain  period;  but  we 
speak  of  the  losses  and  gains  which  have  occurred  during 
the  period.  The  words  asset  and  liability  suggest  the  ques- 
tion, What  is  the  form  of  the  asset  or  liability?  The  words 
loss  and  gain  suggest  the  question,  What  is  the  cause  of  the 
loss  or  gain?  Speaking  of  assets  and  liabilities,  we  would 
say  that  the  asset  in  question  is  in  the  form  of  a  debt  owed  to 
the  proprietor  by  Cash,  or  that  the  liability  in  question  is  in 
the  form  of  a  debt  owed  by  the  proprietor  to  John  Smith; 
but  speaking  of  losses  and  gains,  we  would  say  that  the  loss 
in  question  was  caused  by  Expense,  or  that  the  gain  in 
question  was  caused  by  Interest. 

Assets  and  liabilities  are  classified  according  to  their 
various  forms;  losses  and  gains  are  classified  according  to 
their  various  causes. 

Since  the  words  asset  and  liability  are  opposites  and  the 
words  income  and  outgo  are  opposites,  income  of  asset  is  the 
same  as  outgo  of  liability  and  outgo  of  asset  is  the  same  as 
income  of  liability.  But  in  order  to  give  the  words  income 
and  outgo  a  definite  meaning  when  used  alone,  we  always 
use  them  with  reference  to  asset;  income  meaning  income 
of  asset  (or  outgo  of  liability),  and  outgo  meaning  outgo  of 
asset  (or  income  of  liability).  Income,  then,  means  increase 
of  asset  or  decrease  of  liability;  outgo  means  decrease  of 
asset  or  increase  of  liability.  But  the  ledger  form  of  debit 
and  credit  is  adapted  to  addition  only;  it  does  not  admit  of 
subtraction.  Therefore  income  is  never  expressed  as  decrease 
of  liability,  it  is  always  expressed  as  increase  of  asset;  outgo 
is  never  expressed  as  decrease  of  asset,  it  is  always  expressed 
as  increase  of  liability.! 

The  words  income  and  outgo,  like  the  words  asset  and 
liability  and  the  words  gain  and  loss,  may  be  used  both  in 


DOUBLE-ENTKY    BOOKKEEPING  49 

the  concrete  and  in  the  abstract  sense.  Vln  the  concrete  sense, 
an  income  is  a  thing  which  has  come  in;  in  the  abstract  sense 
it  is  the  act  of  coming^inj  The  thing  which  has  come  in  is 
a  new  asset ;  the  act  of  coming  in  is  gain.  /  In  the  concrete 
sense,  an  outgo  is  a  thing  which  has  gone  out;  in  the  abstract 
sense  it  is  the  act  of  going  out.  The  thing  which  has  gone 
out  is  a  new  liability;  the  act  of  going  out  is  loss. 

When  we  speak  of  the  form  of  an  income,  we  are  using 
the  word  income  in  its  concrete  sense,  it  means  a  new  asset; 
when  we  speak  of  the  cause  of  an  income,  we  are  using  the 
word  income  in  its  abstract  sense,  it  means  gain.  Income  in 
the  form  of  merchandise  is  not  gain,  it  is  asset;  income 
caused  by  dealing  in  merchandise  is  not  asset,  it  is  gain. 

When  we  speak  of  the  form  of  an  outgo,  we  are  using  the 
word  outgo  in  its  concrete  sense,  it  means  a  new  liability; 
when  we  speak  of  the  cause  of  an  outgo,  we  are  using  the 
word  outgo  in  its  abstract  sense,  it  means  loss.  Outgo  in  the 
form  of  merchandise  is  not  loss,  it  is  liability;  outgo  caused 
by  dealing  in  merchandise  is  not  liability,  it  is  loss. 

With  reference  to  this  distinction  it  should  be  noted  that 
when,  for  example,  the  accruing  of  interest  in  our  favor 
causes  an  income  of  cash,  it  causes  the  income,  that  is  to  say, 
the  act  of  coming  in,  but  it  does  not  cause  the  cash ;  it  causes 
the  gain,  but  it  does  not  cause  the  asset.  We  cannot  asso- 
ciate the  idea  of  cause  with  things  which  exist;  we  can  only 
associate  it  with  changes  which  occur. 

Bookkeeping  deals  with  numbers  which  express  value  and 
such  numbers  may  be  concrete  or  they  may  be  abstract.  The 
fact  that  a  number  is  followed  by  the  word  "dollars"  does 
not  necessarily  make  it  concrete.  The  expression  "one  hun- 
dred dollars/'  if  it  refers  to  certain  specified  coins  and 
means  those  identical  coins,  is  a  concrete  number;  but  if  it 
means  simply  value  to  the  amount  of  $100,  it  is  an  abstract 
number.  Numbers  which  express  value,  but  not  the  form 
in  which  the  value  exists,  are  abstract  numbers;  while  num.- 


50  PRINCIPLES    OF 

bers  which  express  value,  and  the  form  in  .which  the  value 
exists,  are  concrete  numbers.  For  example,  $5,000,  $10,000, 
$15,000,  $20,000,  these  are  abstract  numbers;  but  $5,000  in 
cash,  $10,000  in  accounts  receivable,  $15,000  in  merchandise. 
$20,000  in  real  estate,  these  are  concrete  numbers. 

It  will  be  noted  that  the  difference  between  the  concrete 
and  the  abstract,  as  those  words  are  used  in  connection  with 
numbers,  is  the  difference  between  the  specific  and  the  general. 
Now,  for  every  specific  change,  that  is  to  say,  for  every  change 
in  any  particular  asset  or  liability,  there  is,  of  course,  a  cor- 
responding general  change,  that  is  to  say,  a  corresponding 
change  in  the  total  of  the  assets  or  liabilities.  The  number 
which  expresses  the  change  in  the  particular  asset  or  liability 
is  a  concrete  number;  but  the  number  which  expresses  the 
corresponding  change  in  the  total  of  the  assets  or  liabilities 
is  an  abstract  number.  A  change  in  any  particular  asset  or 
liability  is  called  outgo  or  income,  while  the  corresponding 
change  in  the  total  of  the  assets  or  liabilities  is  called  loss 
or  gain.  In,  other  words,  we  generally  use  the  terms  outgo 
and  income  in  the  concrete  sense,  and  the  terms  loss  and  gain 
in  the  abstract  sense.  If,  for  example,  the  cash  on  hand  at 
the  end  of  the  period  is  greater  than  it  was  at  the  beginning, 
the  increase  in  the  amount  of  cash  is  called  income  in  the 
form  of  cash,  while  the  corresponding  increase  in  the  total 
of  the  assets  is  called  gain. 

Changes  in  the  various  assets  and  liabilities  are  classified 
according  to  the  form  of  the  assets  and  liabilities  which 
change,  while  changes  in  the  totals  of  the  assets  and  liabilities 
are  classified  according  to  the  causes  which  produce  the 
changes.  Of  course  the  aggregate  of  the  changes  in  the  vari- 
ous assets  and  liabilities  is  the  same  as  the  aggregate  of  the 
changes  in  the  totals  of  the  assets  and  liabilities,  and  there- 
fore the  net  income  is  always  the  same  as  the  net  gain  (except 
that  income  caused  by  contributions  is  not  counted  as  gain), 
and  the  net  outgo  is  always  the  same  as  the  net  loss  (except 
that  outgo  caused  by  withdrawals  is  not  counted  as  loss). 


DOUBLE-ENTRY   BOOKKEEPING  51 


CHAPTER   VII 

DOUBLE-ENTRY    BOOKKEEPING    REGARDS    ALL    BUSINESS    AS    A 

MATTER    OF    BORROWING    AND    LENDING DISCUSSION    OF 

THE  IDEA  OF  PERSONIFICATION — RULE  FOR  RECORDING 
TRANSACTIONS  AND  EXAMPLES  ILLUSTRATING  IT — THE 
RULE  FOR  DEBITING  AND  CREDITING  IS  NEVER  REVERSED. 

Since  debts  are  the  results  of  loans,  a  system  of  account- 
ing that  keeps  all  the  records  in  the  form  of  debts  must 
necessarily  be  based  upon  the  idea  that  all  business  is  simply 
a  matter  of  borrowing  and  lending.  At  first  thought  that 
idea  would  seem  untenable,  but  in  reality  there  is  nothing 
far-fetched  about  it.  The  typical  operation  in  business  is 
buying  and  selling,  and  every  case  of  buying  and  selling  can 
be  stated  as  a  case  of  borrowing  and  lending.  If,  for  example, 
Smith  sells  a  pair  of  shoes  to  Jones  for  $5.00,  we  can  state 
the  case  just  as  well  by  saying  that  Smith  borrows  $5.00  in 
cash  from  Jones  and  lends  him  $5.00  in  merchandise;  there- 
fore each  of  them  owes  $5.00  to  the  other,  and  therefore 
neither  of  them  owes  anything  to  the  other;  the  two  debts 
cancel  each  other. 

/  At  the  beginning,  then,  we  must  pretend  that  we  borrow 
the  amounts  of  the  liabilities  from  certain  persons  and  lend 
the  amounts  of  the  assets  to  certain  other  persons ;  afterwards, 
in  recording  the  amount  involved  in  each  transaction,  we 
must  pretend  that  we  borrow  it  from  one  person  and  lend  it 
to  another.  It  follows,  therefore,  that  double-entry  book- 
keeping must  use  figurative  language;  it  must  personify  the 
headings  of  the  accounts.  All  such  titles  as  Cash,  Merchan- 
dise, Interest  and  Expense  must  be  regarded  as  the  names  of 
imaginary  persons  from  whom  we  borrow  and  to  whom  we 
lend. 

Bookkeepers  have  always  had  a  vague  idea  of  personifica- 
tion, but  they  have  never  followed  it  to  its  logical  conclusion. 


52  PEINCIPLES    OF 

Apparently  they  have  never  been  able  to  apprehend  the  evi- 
dent fact  that  if  a  man's  assets  and  liabilities  are  always  in 
the  form  of  debts  it  is  impossible  that  he  should  ever  keep 
anything  in  his  possession.  The  consequence  is  that  they 
have  never  been  able  to  make  a  clear  distinction  between 
the  inside  parties  and  the  outside  parties  in  accounting. 
Instead  of  adopting  the  figurative  conception  of  business  in 
place  of  the  literal  conception,  they  try  to  combine  the  two. 
In  the  case  of  a  mercantile  business,  for  example,  they  always 
conceive  of  an  ordinary  store  containing  a  stock  of  mer- 
chandise, and  regard  Cash,  Merchandise,  etc.,  as  imaginary 
employees  of  the  proprietor,  as  inside  parties. 

That  idea  is  entirely  wrong.  In  double-entry  bookkeeping 
the  merchant  has  no  store;  he  has  nothing  but  an  office,  and 
nothing  in  the  office  but  a  desk  and  a  set  of  books.  The  pro- 
prietor (that  is  to  say,  the  proprietor  or  the  proprietors  col- 
lectively) is  the  only  ^inside  party;  he  attends  to  all  the 
business  himself;  no  oneTeTse  has~~anything  to  do  with  it. 

If  a  salesman  comes  in  and  sells  him  $100  worth  of  goods, 
the  merchant  goes  across  the  street  to  a  man  named  Cash  and 
borrows  $100  from  him.  He  gives  the  money  to  the  sales- 
man and  the  salesman  gives  him  the  goods.  The  merchant 
then  takes  the  merchandise  down  the  street  to  a  man  named 
Merchandise  and  lends  it  to  him.  Finally  he  returns  to  his 
office  and  records  in  his  books  the  fact  that  he  borrowed  $100 
from  Mr.  Cash  and  lent  $100  to  Mr.  Merchandise.  In  other 
words,  he  debits  Merchandise  and  credits  Cash. 
\  If  a  customer  comes  in  to  buy  $10  worth  of  goods,  the 
merchant  goes  down  the  street  to  the  man  named  Merchandise 
and  borrows  from  him  the  merchandise  which  the  customer 
wishes  to  buy.  He  gives  the  goods  to  the  customer  and  the 
customer  gives  him  the  money.  The  merchant  then  takes  the 
money  across  the  street  to  the  man  named  Cash  and  lends 
it  to  him.  Finally  he  returns  to  his  office  and  records  in  his 
books  the  fact  that  he  borrowed  $10  from  Mr,  Merchandise 


DOUBLE-ENTRY   BOOKKEEPING  53 

and  lent  $10  to  Mr.  Cash.  In  other  words,,  he  debits  Cash 
and  credits  Merchandise. 

The  point  to  be  observed  is  that  the  imaginary  persons, 
Cash,  Merchandise,  Interest,  Expense,  etc.,  are  not  employees 
of  the  proprietor;  they  have  no  more  to  do  with  the  business 
than  any  other  person  (Smith,  Jones  or  Brown,  for  example) 
from  whom  the  proprietor  borrows  or  to  whom  he  lends ;  they 
are  ouJ^departies.J 

Moreover,  the  outside  parties  are  the  only  ones  who  have 
anything  on  hand;  the  proprietor's  assets  and  liabilities  are 
always  in  the  form  of  debts,  and  therefore  he  cannot  have 
anything  in  his  possession.  When  we  speak  of  counting  the 
cash,  we  do  not  mean  the  cash  which  the  proprietor  has  on 
hand  (he  never  has  anything  on  hand),  we  mean  the  cash 
which  the  person  called  Cash  has  on  hand.  When  we  speak 
of  taking  inventory  of  the  merchandise,  we  do  not 
mean  the  merchandise  which  the  proprietor  has  on  hand 
(he  never  has  anything  on  hand),  we  mean  the  mer- 
chandise which  the  person  called  Merchandise  has  on 
hand.  We  count  the  cash  and  take  inventory  of  the  mer- 
chandise which  these  parties  have  on  hand,  simply  to  deter- 
mine whether  the  debts  which  they  owe  to  the  proprietor  are 
good  or  not.  Since  Cash  and  Merchandise  have  no  cash  or 
merchandise  except  what  the  proprietor  has  lent  to  them,  the 
amount  which  each  of  them  has  on  hand  determines  the 
amount  which  he  will  pay  on  the  debt  which  he  owes  to  the 
proprietor;  in  other  words,  it  determines  to  what  extent  the 
debt  is* good,  and  to  what  extent  (if  any)  the  debt  is  bad. 
If  Cash  and  Merchandise  were  real  persons,  possibly  we  might 
need  an  order  of  the  court  to  authorize  us  to  go  into  their 
places  of  business  and  count  their  cash  and  take  inventory  of 
their  merchandise ;  but  since  they  are  only  imaginary  persons, 
we  can  perform  those  operations  without  any  legal  formality. 

The  reader  can  hardly  fail  to  notice  the  similarity  between 
the  imaginative  part  of  double-entry  bookkeeping  and  the 


54  PRINCIPLES    OF 

"play"  of  children.  When  the  bookkeeper  says  that  he  bor- 
rows from  Cash  and  lends  to  Expense,  he  is  simply  "playing" 
that  he  does  it;  just  as  a  little  girl  plays  that  she  is  having 
a  tea-party,  or  as  a  little  boy  plays  that  a  row  of  chairs  is  a 
railroad  train.  But  there  is  this  difference;  the  child  in  its 
play  is  merely  amusing  itself,  whereas  the  bookkeeper,  by 
"playing"  that  he  is  dealing  with  men  named  Cash,  Merchan- 
dise, Interest,  Expense,  etc.,  has  developed  one  of  the  most 
compact  methods  of  expression  that  have  ever  been  devised 
by  the  human  mind. 

Beginners  in  bookkeeping  seem  to  have  the  idea  that 
single-entry  bookkeeping  is  very  simple,  while  double-entry 
bookkeeping  is  very  complex;  but  as  a  matter  of  fact,  it  is 
the  wonderful  simplicity  of  double-entry  bookkeeping  which 
has  caused  the  almost  total  abandonment  of  single-entry 
bookkeeping.  Probably,  too,  in  its  very  simplicity  is  to  be 
found  the  reason  why  double-entry  bookkeeping  has  never 
been  understood.  Children  can  play  games  of  "pretending," 
and  play  them  right;  but  when  grown  men  try  to  do  it  they 
are  liable  to  make  a  muddle  of  it,  for  the  simple  reason  that 
they  lack  that  vivid  imagination  which  is  characteristic  of 
childhood. 

The  bookkeeper's  idea  of  personification  is  so  vague  that 
in  practice  he  is  inclined  to  take  everything  literally,  to 
think  that  Cash  means  cash  and  Merchandise  means  mer- 
chandise, and  therefore  in  many  cases  his  ideas  are  the 
reverse  of  what  they  should  be.  For  example,  he  often 
states  a  rule  to  this  effect:  Debit  what  you  receive,  credit 
what  you  give.  That  rule,  as  it  stands,  is  an  absurdity. 
We  cannot  debit  or  credit  a  thing;  we  can  only  debit  or  credit 
a  person.  In  bookkeeping,  whenever  we  receive  we  borrow 
and  whenever  we  give  we  lend,  therefore  the  rule  should  be 
stated  in  just  the  opposite  form:  Credit  the  person  from 
whom  you  receive,  debit  the  person  to  whom  you  give.  In 


DOUBLE-ENTRY   BOOKKEEPING  55 

that  form  the  rule  means  something;  in  fact  its  meaning  is 
so  clear  that  it  needs  no  explanation. 

The  following  examples  will  serve  to  illustrate  the  rule, 
and  to  show  how  the  accountant  must  exercise  his  imagina- 
tion in  order  to  understand  the  figurative  language  of  double- 
entry  bookkeeping. 

1.  We  buy  merchandise  to  the  amount  of  $1,000  from 
John  Smith  on  account. 

We  receive  from  Smith  and  give  to  the  person  called 
Merchandise,  therefore  Merchandise  owes  us  and  we  owe 
Smith;  we  debit  Merchandise  and  credit  Smith. 

2.  We  sell  merchandise  to  the  amount  of  $100  to  Wm. 
Jones  on  account. 

We  receive  from  the  person  called  Merchandise  and  give 
to  Jones,  therefore  Jones  owes  us  and  we  owe  Merchandise; 
we  debit  Jones  and  credit  Merchandise. 

3.  We  sell  merchandise  to  the  amount  of  $300  to  Thos. 
Brown  for  cash. 

We  receive  from  the  person  called  Merchandise,  therefore 
we  credit  Merchandise;  we  give  to  Brown,  therefore  we  debit 
Brown;  we  receive  from  Brown,  therefore  we  credit  Brown; 
we  give  to  the  person  called  Cash,  therefore  we  debit  Cash. 
Since  the  debit  and  credit  to  Brown  cancel  each  other,  the 
entries  are  omitted. 

4.  We  buy  merchandise  to  the   amount  of  $80   from 
Robert  Johnson  for  cash. 

We  receive  from  the  person  called  Cash,  therefore  we 
credit  Cash ;  we  give  to  Johnson,  therefore  we  debit  Johnson ; 
we  receive  from  Johnson,  therefore  we  credit  Johnson;  we 
give  to  the  person  called  Merchandise,  therefore  we  debit 
Merchandise.  Since  the  debit  and  credit  to  Johnson  cancel 
each  other,  the  entries  are  omitted. 

5.  We  make  a  payment  of  $50  to  Frank  Robinson  for 
rent. 

We  receive  the  money  from  the  person  called  Cash,  give 


56  PRINCIPLES    OF 

it  to  the  person  called  Expense,  and  Expense  gives  it  to  Robin- 
son. When  we  receive  the  money  from  Cash,  we  credit  Cash ; 
when  we  give  it  to  Expense,  we  debit  Expense ;  when  Expense 
gives  the  money  to  Robinson,  we  are  not  a  party  to  the 
transaction  and  therefore  we  do  not  record  it. 

6.     Geo.  Clark  makes  a  payment  of  $40  to  us  for  interest. 

Clark  gives  the  money  to  the  person  called  Interest, 
Interest  gives  it  to  us  and  we  give  it  to  the  person  called 
Cash.  When  Clark  gives  the  money  to  Interest  we  are  not 
a  party  to  the  transaction  and  therefore  we  do  not  record  it. 
When  we  receive  the  money  from  Interest,  we  credit  Interest ; 
when  we  give  it  to  Cash,  we  debit  Cash. 

It  will  be  noted  that  according  to  this  conception  of 
double-entry  bookkeeping  we  do  not  personify  the  business; 
there  are  no  debts  owed  to  the  business  or  by  the  business; 
every  one  of  the  debts  is  owed  either  to  the  proprietor  or 
by  the  proprietor. 

To  record  the  above  transactions  in  bookkeeping  form 
(writing  the  headings  in  full),  the  entries  are  as  follows: 

JOURNAL 

Dr.  Cr. 

1st  Transaction — 

Merchandise  awes  the  proprietor  and  John 
Smith  is  owed  by  the  proprietor, 

Merchandise,    to    Proprietor (1)     $1,000 

John  Smith,  to  Proprietor (2)  $1,000 

2nd  Transaction — 

Wm.   Jones  owes  the  proprietor  and  Mer- 
chandise is  owed  by  the  proprietor, 

Wm.  Jones,  to  Proprietor (3)          100 

Merchandise,  to  Proprietor (4)  100 

3rd  Transaction — 

Cash  owes  the  proprietor  and  Merchandise 
is  owed  by  the  proprietor, 

Cash,  to  Proprietor (5)          300 

Merchandise,  to  Proprietor (6)  300 

4th  Transaction — 

Merchandise  owes  the  proprietor  and  Cash 
is  owed  by  the  "proprietor, 

Merchandise,  to  Proprietor (7)  80 

Cash,  to  Proprietor (8)  80 


DOUBLE-ENTKY   BOOKKEEPING 


5th  Transaction — 

Expense  owes  the  proprietor  and  Cash  is 
owed  by  the  proprietor, 

Expense,    to    Proprietor (9)  50 

Cash,    to    Proprietor (10)  50 

6th  Transaction — 

Cash  owes  the  proprietor  and  Interest  is 
owed  by  the  proprietor, 

Cash,  to  Proprietor (11)  40 

Interest,  to  Proprietor     (12)  40 

LEDGER 


Dr. 

Merchandise             Cr. 
To  Proprietor 

Dr. 

John  Smith             Cr. 
To  Proprietor 

(1) 
(7) 

$1,000 
80 

(4)               $100 
(6)                 300 

(2)            $1,000 

Dr. 

Wm.  Jones              Cr. 
To  Proprietor 

Dr. 

Cash                   Cr. 
To  Proprietor 

(3) 

$100 

(5) 
(11) 

$300 
40 

(8)                 $80 
(10)                 50 

Dr. 

Expense                Cr. 
To  Proprietor 

Dr. 

Interest                Cr. 
To  Proprietor 

(9) 

$50 

(12)               $40 

By  taking  the  difference  between  the  two  sides  in  each 
of  the  above  accounts  we  get  the  following  results: 

Merchandise  owes  the  proprietor $680 

Cash  owes  the  proprietor 210 

Wm.  Jones  owes  the  proprietor 100 

Expense   owes   the   proprietor 50 

$1,040 


John  Smith  is  owed  by  the  proprietor $1,000 

Interest  is  owed  by  the  proprietor 40 

$1,040 


58  PRINCIPLES    OF 

In  order  to  determine  the  assets  and  liabilities  and  the 
losses  and  gains  we  must  appraise  the  values  of  these  debts. 

To  estimate  the  value  of  the  debt  of  $680  which  the 
person  called  Merchandise  owes  us,  we  take  an  inventory  of 
the  merchandise  which  he  has  on  hand.  The  value  determined 
by  inventory  is  the  amount  which  he  will  pay,  and  represents 
an  asset.  If  the  asset  equals  the  amount  of  the  debt,  there  is 
no  loss  nor  gain;  if  the  asset  is  less  than  the  amount  of  the 
debt,  the  difference  is  loss;  if  the  asset  is  greater  than  the 
amount  of  the  debt,  the  difference  is  gain. 

We  determine  the  value  of  the  debt  of  $210  which  Cash 
owes  us,  in  the  same  way,  that  is  to  say,  by  counting  the 
cash.  Since  the  amount  of  the  debt  is  the  difference  between 
what  we  have  given  to  the  person  called  Cash  and  what  we 
have  received  from  him,  it  should  agree  with  the  amount 
which  he  has  on  hand. 

Our  estimate  of  the  value  of  the  debt  of  $100  which 
Wm.  Jones  owes  us  depends  upon  our  opinion  of  Jones. 
If  we  think  that  he  will  pay  it,  we  count  it  as  an  asset. 
If  we  think  that  he  will  pay  only  part  of  it,  we  count  that 
part  of  it  as  an  asset  and  the  rest  of  it  as  a  loss.  If  we 
think  that  he  will  not  pay  anything,  we  count  it  all  as  a  loss. 

The  debt  of  $50  which  the  person  called  Expense  owes 
us  will  not  be  paid,  therefore  we  count  it  as  a  loss. 

We  will  have  to  pay  the  debt  of  $1,000  which  we  owe  to 
John  Smith,  therefore  we  count  it  as  a  liability. 

We  will  not  have  to  pay  the  debt  of  $40  which  we  owe 
to  the  person  called  Interest,  therefore  we  count  it  as  a  gain. 


The  failure  to  understand  the  figurative  language  of 
double-entry  bookkeeping  has  given  rise  to  a  very  wide-spread 
error  in  regard  to  two  classes  of  accounts.  The  bookkeeper 
thinks  that  in  accounts  like  Cash  and  Merchandise  we  debit 
when  we  receive  and  credit  when  we  give,  and  that  in  accounts 


DOUBLE-ENTRY    BOOKKEEPING  59 

like  Interest  and  Expense  we  credit  when  we  receive  and 
debit  when  we  give.     In  other  words,  he  thinks  that  in  the  // 
one  class  of  accounts  as  compared  with  the  other,  the  rule  for  I; 
debiting  and  crediting  is  reversed. 

That  idea  is  entirely  wrong.     In  accounts  like  Cash  and  N 
Merchandise  as  compared  with  accounts  like  Interest  and    \ 
Expense,  there  is  a  reversal,  but  it  is  not  a  reversal  in  the    / 
rule  for  debiting  and  crediting;  it  is  simply  a  reversal  in/ 
the  method  of  naming  the  accounts,  j  Accounts  like  Interest 
and  Expense  deal  with  causes  of  outgo  and  income ;  accounts 
like  Cash  and  Merchandise  deal  with  things.     Now  one  of 

the  primary  instincts  of  mankind  is  to  resort  to  personification > 

for  the  purpose  of  expressing  abstract  icleas  in  concrete  form. 
It  is,  therefore,  a  fundlmentariaw~of  the  human  mind  that 
it  never  personifies  things,  since  things  are  already  concrete. 
It  may  personify  the  abstract  ideas  which  it  associates  with 
a  certain  thing,  but  it  does  not  personify  the  thing  itself. 

In  accordance  with  that  law,  double-entry  bookkeeping 
personifies  actions  or  the  causes  of  actions,  but  .it  never 
personifies  things.  Interest  is  the  personification  of  interest ; 
but  Cash  is  not  the  personification  of  cash,  it  is  the  personi- 
fication of  the  act  of  handling  cash.  In  accounts  like  Interest 
and  Expense  we  personify  that  which  acts,  and  the  name 
which  we  give  to  this  imaginary  person  is  descriptive  of  that 
which  acts.  In  accounts  like  Cash  and  Merchandise  we  per- 
sonify that  which  acts,  but  the  name  which  we  give  to  this 
imaginary  person  is  descriptive  of  the  thing  which  is  acted 
upon.  The  principle  which  governs  in  naming  the  accounts 
in  the  one  case  is  the  reverse  of  the  principle  which  governs 
in  the  other. 

But  in  bookkeeping  there  is  no  reversal  of  the  rule  for 
debiting  and  crediting.     We  always  credit  the  person  from  I 
whom  we  receive  and  debit  the  person  to  whom  we  give;/ 
there  is  no  exception  to  that  rule.    When  money  is  paid  in 
for  interest,  we  receive  from  Interest  and  give  to  Cash.    When 


GO  PEINCIPLES    OF 

we  receive  the  money  from  Interest,  we  credit  Interest;  when 
we  give  it  to  Cash,  we  debit  Cash.  When  money  is  paid  out 
for  expenses,  we  receive  from  Cash  and  give  to  Expense. 
When  we  receive  the  money  from  Cash,  we  credit  Cash ;  when 
we  give  it  to  Expense,  we  debit  Expense. 


DOUBLE-ENTRY    BOOKKEEPING  61 


CHAPTEE   VIII 

DOUBLE-ENTRY  BOOKKEEPING  IS  DUPLICATE-ENTRY  BOOKKEEP- 
ING  ACCOUNTS    OF    ORIGINAL   ENTRY   AND  ACCOUNTS    OF 

DUPLICATE        ENTRY SCHEDULE        OF        ACCOUNTS THE 

ACCOUNTS  OF  ORIGINAL  ENTRY  SHOW  ACTUAL  AND  THE 
ACCOUNTS  OF  DUPLICATE  ENTRY  SHOW  IMAGINARY  SUB- 
DIVISIONS OF  THE  NET  CAPITAL — THE  ACCOUNTS  OF  AN 
INDIVIDUAL  OR  OF  A  FIRM  CAN  BE  KEPT  IN  THE  SAME 
FORM  AS  THOSE  OF  A  CORPORATION. 

The  example  given  in  the  preceding  chapter  contains 
nothing  but  transactions,  and  since  a  transaction  always  gives 
rise  to  two  equal  and  opposite  debts,  it  is  easy  to  understand 
why  the  amount  involved  in  the  operation  is  entered  both 
as  a  debit  and  as  a  credit.  Jin  every  transaction  the  pro- 
prietor borrows  from  one  party  and  lends  to  another,  there- 
fore one  of  the  parties  is  creditor  to  the  proprietor  and 
the  other  is  debtor  to  the  proprietor.  But  when  the  pro- 
prietor contributes  capital  he  lends  to  one  party  without 
borrowing  from  another,  and  when  he  withdraws  capital  he 
borrows  from  one  party  without  lending  to  another.  In  the 
case  of  a  contribution  or  a  withdrawal  there  is  only  one 
debt,  and  therefore  the  question  arises,  How  is  it  possible  to 
record  a  single  debt  so  as  to  keep  debits  and  credits  equal? 
The  answer  to  that  question  is,  By  recording  the  debt  in 
duplicate. 

In  double-entry  bookkeeping  we  regard  the  debts  as  being 
between  the  proprietor  and  the  outside  parties  severally  and 
collectively,  and  for  that  reason  we  record  them  twice.    Every 
debt  which  is  owed  to  the  proprietor  by  one  of  the  outside 
parties  is  also  regarded  as  being  owed  to  the  proprietor  by  I 
all  of  the  outside  parties  collective^,  and  every  debt  which   i 
is  owed  by  the  proprietor  to  one  of  the  outside  parties  is  / 
also  regarded  as  being  owed  by  the  proprietor  to  all  of  the/ 


62  PRINCIPLES    OF 

outside    parties    collectively.      We    have    specific    accounts 
between  the  proprietor  and  the  outside  parties  severally,  and 
we  also  have  a  general  account  between  the  proprietor  and 
the  outside  parties  collectively.    The  former  are  the  accounts 
of  original  entry ;  the  latter  is  the  account  of  duplicate  entry. 
In  every  account  of  original   entry   one  of  the  outside 
/  parties  is  the  first  party  and  the  proprietor  is  the  second 
/    party.    A  debit  entry  means  that  the  outside  party  owes  the 
/     proprietor,  and  a  credit  entry  means  that  the  outside  party  is 
/      owed  by  the  proprietor. 

In  the  account  of  duplicate  entry  the  proprietor  is  the 
first  party  and  the  outside  parties  collectively  are  the  second 
I       party.    A  debit  entry  means  that  the  proprietor  owes  the  out- 
side parties  collectively,  and  a  credit  entry  means  that  the 
proprietor  is  owed  by  the  outside  parties  collectively ._/  (The 
I      reader  will  observe  that  we  have  here  the  answer  to  the 
\     question  which  was  raised  in  Chapter  II,  namely,  Who  is  the 
\ second  party  in  the  proprietor's  account?)     b   5  V 

The  fact  that  in  the  account  of  duplicate  entry,  as  com- 
pared with  the  accounts  of  original  entry,  the  order  of  the 
parties  is  reversed  is  what  keeps  debits  and  credits  equal, 
since  every  debt  which  is  recorded  as  a  debit  in  an  account  of 
original  entry  is  recorded  as  a  credit  in  the  account  of 
duplicate  entry,  and  every  debt  which  is  recorded  as  a  credit 
in  an  account  of  original  entry  is  recorded  as  a  debit  in  the 
account  of  duplicate  entry. 

Each  account  of  original  entry  records  the  relations 
between  the  proprietor  and  one  of  the  outside  parties;  the 
account  of  duplicate  entry  records  the  relations  between  the 
proprietor  and  all  of  the  outside  parties  collectively. 

Each  account  of  original  entry  records  the  asset  or  lia- 
bility existing  in  the  form  indicated  by  the  heading  of  the 
account;  the  account  of  duplicate  entry  records  the  net 
asset  or  net  liability — the  net  capital. 

Each  account  of  original  entry  records  the  loss  or  gain 


DOUBLE-ENTKY   BOOKKEEPING 


63 


caused  by  the  heading  of  the  account;  the  account  of  dupli- 
cate entry  records  the  net  loss  oj^ej^airi.! 

Theoretically,  we  do  all  of  the  work  twice,  and  the  results 
mutually  check  each  other;  practically,  we  do  very  little 
of  the  work  twice,  since  the  great  majority  of  the  entries 
which  otherwise  would  be  made  in  the  account  of  duplicate 
entry,  cancel  each  other  and  therefore  are  omitted. 

In  double-entry  bookkeeping,  then,  we  have  specific 
accounts  of  original  entry  and  a  general  account  of  duplicate 
entry.  But  the  term  general  account,  in  the  sense  in  which 
it  is  used  here,  does  not  necessarily  mean  one  general  account 
as  distinguished  from  various  specific  accounts;  it  means  a 
general  account  between  the  proprietor  and  all  of  the  out- 
side parties  collectively,  as  distinguished  from  a  specific 
account  between  the  proprietor  and  one  of  the  outside  parties. 
When  carried  in  the  form  of  one  account  it  is  the  proprietor's  ' 
account,  net  capital  account;  but  it  may  be,  and  often  is 
carried  in  the  form  of  various  subordinate  accounts,  which 
in  the  aggregate  are  equivalent  to  net  capital  account. 

The  various  classes  of  accounts  which  are  used  in  double- 
entry  bookkeeping  are  shown  in  the  following  schedule: 


Accounts  of 
Original  Entry 


Personal 
Accounts 


Bills  Receivable 
Bills  Payable 

Property 
Accounts 


{Individuals 
Firms 
Corporations 
Personal  Acc'ts  of 
Proprietors 


rcash 

I  Merchandise 
1  Real  Estate 
lEtc.,  Etc. 


. 


< 


Acc'ts  Representing  ("Interest 
Causes  of  Outgo  \  Expense 
and  Income 


Accounts  of 

Duplicate  Entry 


Net  Capital 
Account 


I  Etc.,  Etc. 
fPartnership  Acc'ts 
I  Capital  Stock 
1  Surplus 
lEtc.,  Etc. 


64  PRINCIPLES    OF 

The  number  of  possible  accounts  is  unlimited,  since  (in 
addition  to  the  names  of  individuals,  firms  and  corporations) 
any  word  or  phrase  which  expresses  the  form  of  an  asset  or 
liability  or  the  cause  of  an  outgo  or  income  may  be  used  as 
the  heading  of  an  account  of  original  entry,  and  any  word  or 
phrase  which  expresses  the  reason  or  purpose  for  which  a  por- 
1  tion  of  the  net  capital  is  supposed  to  be  set  aside  or  reserved 
may  be  used  as  the  heading  of  an  account  of  duplicate  entry. 

•  The  accounts  of  original  entry  are  easy  to  understand. 

In  each  of  these  accounts  one  of  the  outside  parties  is  the 
first  party  and  the  proprietor,  whether  an  individual,  a  firm 
or  a  corporation,  is  the  second  party.  Therefore  a  debit  entry 
means  that  the  outside  party  owes  the  proprietor,  a  credit 
entry  means  that  he  is  owed  by  the  proprietor,  and  the  bal- 
ance of  the  account  always  shows  the  net  debt  which  he 
owes  to,  or  is  owed  by,  the  proprietor.  If  the  debt  is  owed  to 
the  proprietor,  then  to  the  extent  to  which  it  is  good  it  repre- 
sents asset,  and  to  the  extent  to  which  it  is  bad  it  represents 
loss.  If  the  debt  is  owed  by  the  proprietor,  then  to  the  extent 
to  which  it  is  good  it  represents  liability,  and  to  the  extent 
to  which  it  is  bad  it  represents  gain. 

Net  capital  account  is  also  easy  to  understand.  In  this 
account  the  proprietor  is  the  first  party  and  the  outside 
parties  collectively  are  the  second  party.  Therefore  a  debit 
entry  means  that  the  proprietor  owes  the  outside  parties  col- 
lectively, a  credit  entry  means  that  he  is  owed  by  the  outside 
parties  collectively,  and  the  balance  of  the  account  always 
shows  the  net  debt  which  he  owes  to,  or  is  owed  by,  the  out- 
side parties  collectively.  If  the  debt  is  owed  to  the  proprietor, 
then  to  the  extent  to  which  it  is  good  it  represents  net 
asset,  and  to  the  extent  to  which  it  is  bad  it  represents  net 
loss.  If  the  debt  is  owed  by  the  proprietor,  then  to  the 
extent  to  which  it  is  good  it  represents  net  liability,  and  to 
the  extent  to  which  it  is  bad  it  represents  net  ffain._j 

But  partnership  accounts  and  accounts  like  Capital  Stock 


DOUBLE-ENTRY   BOOKKEEPING 


65 


and  Surplus  are  not  so  easy  to  understand,  because  the  rela- 
tion of  the  proprietor  to  these  accounts  is  not  so  evident. 
In  order  to  understand  them  one  must  keep  clearly  in  mind 
the  fact  that  the  heading  of  every  such  account  is  included  in 
the  term  proprietor.  In  the  case  of  the  firm  of  Smith  & 
Jones,  whatever  is  done  by  Smith  as  a  member  of  the  firm  is 
done  by  the  firm;  whatever  is  done  by  Jones  as  a  member 
of  the  firm  is  done  by  the  firm.  In  like  manner,,  a  debit  to 
Smith  as  a  member  of  the  firm  is  a  debit  to  the  firm,  a  credit 
to  Jones  as  a  member  of  the  firm  is  a  credit  to  the  firm.  In 
the  case  of  a  company,  a  credit  to  Capital  Stock  is  a  credit  to 
the  company,  a  debit  to  Surplus  is  a  debit  to  the  company. 
If  the  titles  were  written  in  full,  the  accounts  would 
appear  in  the  books  of  an  individual  proprietor  in  this  form: 


Dr. 


ACCOUNTS  OF  ORIGINAL  ENTRY 
Cash 

To  Proprietor 


Cr. 


Dr. 


Merchandise 

To  Proprietor 


Cr. 


Dr. 


Interest 

To  Proprietor 


Cr. 


66 
Dr. 


PRINCIPLES    OF 

Expense 

To  Proprietor 


Cr. 


Dr. 


ACCOUNT  OF  DUPLICATE  ENTBY 

Proprietor 

To  Outside  Parties 


Cr. 


In  the  books  of  the  firm  of  Smith  &  Jones  the  accounts 
would  be  in  this  form : 


Dr. 


ACCOUNTS  OF  ORIGINAL  ENTBY 

Cash 

To  Firm 


Cr. 


Dr. 


Merchandise 
To  Firm 


Cr. 


Dr. 


Interest 

To  Firm 


Cr. 


Dr. 


DOUBLE-ENTKY   BOOKKEEPING  67 

Expense  Cr. 

To  Firm 


Dr. 


ACCOUNTS  OF  DUPLICATE  ENTRY 
Firm  (John  Smith) 
To  Outside  Parties 


Dr. 


Firm  (Wm.  Jones) 
To  Outside  Parties 


Cr. 


In  the  books  of  a  corporation  the  accounts  would  be  in 
this  form: 


Dr. 


ACCOUNTS  OF  ORIGINAL  ENTRY 
Cash 

To  Company 


Cr. 


Dr. 


Merchandise 

To  Company 


Cr. 


68 
Dr. 


PKINCIPLES    OF 

Interest 

To  Company 


Cr. 


Dr. 


Expense 

To  Company 


Cr. 


Dr. 


ACCOUNTS  OF  DUPLICATE  ENTRY 
Company   (Capital  Stock) 
To  Outside  Parties 


Cr. 


Dr. 


Company   (Surplus) 

To  Outside  Parties 


Cr. 


Bearing  in  mind  that  the  word  firm  means  the  partners 
collectively  and  that  the  word  company  means  the  stock- 
holders collectively,  the  reader  will  note  from  the  above 
examples  that  in  double-entry  bookkeeping  there  is  no  inter- 
mediate party;  the  accounts  are  between  the  proprietor,  or 
the  proprietors  collectively,  on  the  one  side,  and  the  outside 
parties  severally  and  collectively,  on  the  other  side.  In  the 
case  of  the  firm  of  Smith  &  Jones,  Smith's  proprietorship 
account  means  simply  that  of  the  total  net  capital  belonging 
to  the  partners  collectively,  a  certain  portion  represents 


DOUBLE-ENTRY    BOOKKEEPING  69 

Smith's  interest.  In  the  case  of  a  company,  capital  stock 
account  means  simply  that  of  the  total  net  capital  belonging 
to  the  stockholders  collectively,  a  certain  portion  represents 
what  they  have  contributed. 

In  practice,  the  bookkeeper  never  writes  the  name  of 
the  second  party ;  he  heads  each  of  his  accounts  with  the  name 
of  the  first  party  only.  In  practice,  then,  Smith's  proprietor- 
ship account  is  in  this  form: 

Dr.  John  Smith  (Proprietorship  Account)  Cr. 


$40,000 


The  bookkeeper  thinks  that  that  account  means  that  Smith 
is  owed  $40,000  by  the  firm,  but  as  a  matter  of  fact  it  means 
nothing  of  the  kind ;  it  means  that  Smith,  as  a  member  of  the 
firm,  is  owed  $40,000  by  the  outside  parties  collectively. 

In  practice,  capital  stock  account  is  in  this  form : 
Dr.  Capital  Stock  Cr. 


$100,000 

That  account  does  not  mean  that  the  stockholders  are 
owed  $100,000  by  the  company;  it  means  that  the  com- 
pany (that  is  to  say,  the  stockholders)  is  owed  $100,000  by 
the  outside  parties  collectively. 

The  above  discussion  brings  out  the  fact  that  in  double- 
entry  bookkeeping  we  have,  or  may  have,  two  separate  divi- 
sions of  the  net  capital,  one  shown  by  the  accounts  of  original 
entry  and  the  other  shown  by  the  accounts  of  duplicate  entry. 
The  net  capital  regarded  as  the  algebraical  sum  of  the  assets 
and  the  liabilities,  is  a  concrete  quantity,  because  we  can 
point  out  the  assets  and  liabilities  which  compose  it  (it  is 
composed  of  all  the  assets  and  liabilities).  But  the  net  capital 


70  PRINCIPLES    OF 

regarded  as  the  arithmetical  difference  between  the  assets 
and  the  liabilities  is  an  abstract  quantity,  because  we  cannot 
point  out  the  assets  (or  liabilities)  which  compose  it.  After 
subtracting  the  total  of  the  liabilities  from  the  total  of  the 
assets,  we  cannot  specify  any  particular  assets  as  remaining; 
therefore  the  arithmetical  difference  between  the  assets  and 
the  liabilities  is  an  abstract  quantity. 

As  stated  in  Chapter  VI,  the  difference  between  the  con- 
crete and  the  abstract,  as  those  words  are  used  in  connection 
with  numbers,  is  the  difference  between  the  specific  and  the 
general.  A  number  which  represents  a  specific  good  debt, 
that  is  to  say,  a  debt  between  the  proprietor  and  one  of  the 
outside  parties,  is  a  concrete  number;  while  a  number  which 
represents  a  debt  between  the  proprietor  and  all  of  the  outside 
parties  collectively  is  an  abstract  number.  The  accounts  of 
original  entry,  then,  show  the  assets  and  liabilities,  the  con- 
crete parts  which  make  up  the  net  capital;  in  other  words, 
they  show  how  the  net  capital  as  a  concrete  quantity  is 
divided.  But  the  accounts  of  duplicate  entry  do  not  show 
how  the  net  capital  is  divided;  they  show  how  the  net 
capital  as  an  abstract  quantity  is  supposed  to  be  divided; 
it  is  purely  an  imaginary  division.  In  the  case  of  a 
firm,  we  cannot  point  out  certain  assets  and  say  that  these 
represent  one  partner's  interest  and  these  represent  another 
partner's  interest;  in  the  case  of  a  company  we  cannot  point 
out  certain  assets  and  say  that  these  represent  the  capital 
stock  and  these  represent  the  surplus;  there  is  no  such  divi- 
sion, except  in  the  books. 

In  his  use  of  accounts  of  duplicate  entry  the  bookkeeper 
always  follows  a  certain  routine.  In  the  case  of  an  individual 
proprietor,  he  carries  net  capital  account,  the  proprietor's 
account;  in  the  case  of  a  firm,  he  omits  the  firm's  account  and 
carries  the  proprietorship  accounts  of  the  various  partners 
in  its  place;  in  the  case  of  a  company,  he  omits  the  com- 
pany's account  and  carries  accounts  like  Capital  Stock  and 


DOUBLE-ENTRY   BOOKKEEPING  71 

Surplus  in  its  place.  Theoretically,  however,  there  is  no 
reason  why  the  accounts  of  an  individual  proprietor  or  of 
a  firm  should  not  be  carried  in  the  same  form  as  those  of  a 
corporation,  if  it  were  thought  worth  while  to  do  so.  The 
object  of  the  account  called  Capital  Stock  is  to  show  the 
amount  of  capital  contributed  by  the  stockholders.  The  title 
Capital  Stock,  then,  is  equivalent  to  the  title  Contributed 
Capital,  and  the  titles  Contributed  Capital,  Surplus,  etc., 
apply  to  the  accounts  of  an  individual  or  of  a  firm 
as  well  as  to  those  of  a  corporation.  Of  course,  in  the 
case  of  a  firm,  if  we  carried  accounts  like  Contributed  Capital 
and  Surplus,  we  could  not  carry  partnership  accounts;  but 
when  each  partner's  interest  is  fixed  at  a  certain  fractional 
part  of  the  whole,  partnership  accounts  are  unnecessary.  If 
the  total  of  the  net  capital  is  known,  there  is  no  need  of 
carrying  accounts  in  the  ledger  to  show  what  a  half  or  a 
third  or  a  quarter  of  it  would  be. 


72  PRINCIPLES    OF 


CHAPTER   IX 

EXAMPLES  ILLUSTRATING  DUPLICATE  ENTRY — DIFFERENCE 
BETWEEN  THE  THEORY  OF  DUPLICATE  ENTRY  AND  THE 
COMMON  THEORY  OF  DOUBLE-ENTRY  BOOKKEEPING. 

When  we  say  that  in  double-entry  bookkeeping  every  debt 
is  recorded  in  duplicate,  we  do  not  mean  that  every  debt  is 
recorded  twice  in  the  same  form ;  we  mean  that  it  is  recorded 
in  two  different  forms,  once  as  a  debt  between  the  proprietor 
and  one  of  the  outside  parties  and  again  as  a  debt  between  the 
proprietor  and  all  of  the  outside  parties  collectively.  And 
when  we  say  that  every  debt  is  recorded  twice,  we  mean  that 
theoretically  it  is  recorded  twice.  In  practice  it  often  happens 
that  two  or  more  duplicate  entries  which  are  to  be  made  at 
the  same  time  either  wholly  or  partially  cancel  each  other, 
and  then  to  the  extent  to  which  they  cancel  each  other  they 
are  omitted. 

If  in  practice  as  well  as  in  theory  every  debt  had  to  be 
recorded  twice,  it  would  make  double-entry  bookkeeping  a 
very  cumbersome  process,  but  fortunately  the  great  majority 
of  the  entries  which  are  made  in  accounting  are  made  to 
record  transactions  and  in  recording  a  transaction  the  dupli- 
cate entries  always  cancel  each  other,  since  a  transaction 
always  gives  rise  to  two  equal  and  opposite  debts.  In  the  case 
of  a  sale  of  merchandise  for  cash,  for  example,  the  proprietor 
borrows  from  the  person  called  Merchandise  and  lends  to  the 
person  called  Cash,  therefore  Cash  owes  the  proprietor  and 
Merchandise  is  owed  by  the  proprietor.  The  entries  to  record 
these  debts  are  as  follows : 

JOURNAL 

Dr.  Cr. 

Cash,  to  Proprietor (1)     $100 

Merchandise,    to    Proprietor (2)  $100 


DOUBLE-ENTKY   BOOKKEEPING  73 

LEDGER 

Dr.  Cash  Cr. 

To  Proprietor 

(1)         $100 

Dr.  Merchandise  Cr. 

To  Proprietor 


(2)         $100 


Here  we  are  not  recording  the  same  debt  twice;  we  are 
recording  two  distinct  debts.  The  first  entry  records  the 
debt  which  the  outside  party  called  Cash  owes  to  the  pro- 
prietor, and  the  second  entry  records  the  debt  which  the 
proprietor  owes  to  the  outside  party  called  Merchandise.  If 
we  recorded  these  debts  in  duplicate  we  would  have  to  record 
each  of  them  twice,  once  as  a  debt  between  the  proprietor  and 
one  of  the  outside  parties  and  again  as  a  debt  between  the 
proprietor  and  all  of  the  outside  parties  collectively.  The 
entries,  then,  would  be  as  follows: 

JOURNAL 

Dr.  Cr. 

Cash,  to  Proprietor (1)     $100 

Proprietor,  to  Outside  Parties (2)  $100 

Merchandise,  to  Proprietor (3)  100 

Proprietor,  to  Outside  Parties (4)       100 

LEDGER 

Dr.  Cash  Cr. 

To  Proprietor 

(1)         $100 


74 
Dr. 


PRINCIPLES    OF 

Merchandise 

To  Proprietor 


Cr 


(3)         $100 


Dr. 


Proprietor 

To  Outside  Parties 


Cr. 


(4)         $100 


(2)         $100 


Here  the  debit  and  credit  to  the  proprietor  cancel  each 
other.  It  follows,  then,  that  in  recording  a  transaction  the 
entries  are  made  in  the  accounts  of  original  entry  only,  since 
the  duplicate  entries  always  cancel  each  other  and  therefore 
are  omitted. 

But  while  a  transaction  gives  rise  to  two  equal  and  oppo- 
site debts,  a  contribution  or  a  withdrawal  only  gives  rise  to 
one  debt,  therefore  in  practice  as  well  as  in  theory  a  contribu- 
tion or  a  withdrawal  is  always  recorded  in  duplicate. 

When  the  proprietor  contributes  $1,000  in  cash,  he  lends 
the  amount  to  the  person  called  Cash;  therefore  Cash  owes 
the  proprietor.  This  debt  is  recorded  in  duplicate  as  follows : 

JOURNAL 

Dr.  Cr. 

Cash,  to   Proprietor (1)     $1,000 


Proprietor,  to  Outside  Parties, 


..(2) 


$1,000 


LEDGEB 


Dr. 

Cash                   Cr. 
To  Proprietor 

Dr.              Proprietor               Cr. 
To  Outside  Parties 

(1) 

$1,000 

(2)     $1,000 

| 

DOUBLE-ENTBY    BOOKKEEPING  75 

The  first  entry  records  a  debt  of  $1,000  as  being  owed 
to  the  proprietor  by  the  outside  party  called  Cash,,  and  the 
second  entry  records  the  same  debt  as  being  owed  to  the 
proprietor  by  the  outside  parties  collectively. 

To  record  a  contribution,  then,  we  debit  one  of  the  out- 
side parties  and  credit  the  proprietor,  and  to  record  a  with- 
drawal we  credit  one  of  the  outside  parties  and  debit  the 
proprietor. 

To  open  the  books : 

An  asset  at  the  beginning  is  recorded  in  the  same  way  as 
a  contribution,  and  a  liability  at  the  beginning  is  recorded  in 
the  same  way  as  a  withdrawal.  If  at  the  time  of  opening 
the  books  the  proprietor  has  certain  liabilities  as  well  as  cer- 
tain assets,  the  duplicate  entries  partially  cancel  each  other 
and  to  that  extent  they  are  omitted. 

As  an  example  to  illustrate  the  method  of  opening  the 
books  we  will  assume  that  the  proprietor's  assets  are  $1,000 
in  cash  and  $10,000  worth  of  merchandise,  and  that  his  lia- 
bilities amount  to  $3,000  in  the  form  of  bills  payable. 

In  order  to  record  these  assets  and  liabilities  in  the 
figurative  language  of  double-entry  bookkeeping,  we  must 
pretend  that  the  proprietor  lends  the  amounts  of  the  assets 
to  certain  outside  parties  called  Cash  and  Merchandise,  and 
that  he  borrows  the  amount  of  the  liabilities  from  a  certain 
outside  party  called  Bills  Payable.  Therefore  the  asset  in  the 
form  of  cash  is  expressed  as  a  debt  owed  to  the  proprietor  by 
the  person  called  Cash,  the  asset  in  the  form  of  merchandise 
is  expressed  as  a  debt  owed  to  the  proprietor  by  the  person 
called  Merchandise,  and  the  liability  in  the  form  of  bills 
payable  is  expressed  as  a  debt  owed  by  the  proprietor  to  the 
person  called  Bills  Payable.  We  record  each  of  these  debts 
twice,  once  as  a  debt  between  the  proprietor  and  one  of  the 
outPide  parties  and  again  as  a  debt  between  the  proprietor  and 
all  of  the  outside  parties  collectively. 


PRINCIPLES    OF 


The  entries  are  as  follows : 

JOURNAL 


Cash,  to  Proprietor (1) 

Proprietor,  to  Outside  Parties  ( 2 ) 

Merchandise,  to  Proprietor (3) 

Proprietor,  to  Outside  Parties (4) 

Bills  Payable,  to  Proprietor (5) 

Proprietor,  to  Outside  Parties (6) 

LEDGER 


Dr. 

$1,000 

10,000 


3,000 


Cr. 

$1,000 

10,000 
3,000 


Dr.                  Cash                   Cr. 
To  Proprietor 

Dr.            Merchandise            Cr. 
To    Proprietor 

(1)     $1,000 

(3)   $10,000 

. 

Dr.          Bills  Payable           Cr. 
To  Proprietor 

Dr.              Proprietor               Cr. 
To  Outside  Parties 

(5)     $3,000 

(6)     $3,000 
Bal.            8,000 

(2)     $1,000 
(4)     10,000 

$11,000 

$11,000 

Bal.           $8,000 

The  first  entry  records  a  debt  of  $1,000  as  being  owed  to 
the  proprietor  by  the  outside  party  called  Cash,  and  the 
second  entry  records  the  same  debt  as  being  owed  to  the 
proprietor  by  all  of  the  outside  parties  collectively.  The  third 
entry  records  a  debt  of  $10,000  as  being  owed  to  the  proprietor 
by  the  outside  party  called  Merchandise,  and  the  fourth  entry 
records  the  same  debt  as  being  owed  to  the  proprietor  by  all 
of  the  outside  parties  collectively.  The  fifth  entry  records  a 
debt  of  $3,000  as  being  owed  by  the  proprietor  to  the  outside 
party  called  Bills  Payable,  and  the  sixth  entry  records  the 
same  debt  as  being  owed  by  the  proprietor  to  all  of  the  out- 
side parties  collectively. 

The  debits  and  credits  to  the  proprietor  partially  cancel 
each  other,  and  therefore  it  is  unnecessary  to  enter  them 


DOUBLE-ENTRY   BOOKKEEPING  77 

separately.  To  the  extent  to  which  they  cancel  each  other 
they  are  omitted;  only  the  excess  of  the  one  side  over  the 
other  is  entered. 

The  entries  to  open  the  books,  then,,  are  as  follows : 

JOURNAL 

Dr.  Cr. 

Cash,   to  Proprietor (1)     $1,000 

Merchandise,  to  Proprietor (2)     10,000 

Bills  Payable,  to  Proprietor (3)  $3,000 

Proprietor,  to  Outside  Parties (4)  8,000 

LEDGER 


Dr. 


Cash  Cr. 

To  Proprietor 


Dr. 


Merchandise  Cr. 

To   Proprietor 


(1)     $1,000 

(2)   $10,000 

Dr.           Bills  Payable           Cr. 
To  Proprietor 

Dr.              Proprietor               Cr. 
To  Outside  Parties 

(3)     $3,000 

(4)     $8,000 

These  entries  mean  that  the  outside  party  called  Cash 
owes  $1,000  to  the  proprietor;  that  the  outside  party  called 
Merchandise  owes  $10,000  to  the  proprietor;  that  the  outside 
party  called  Bills  Payable  is  owed  $3,000  by  the  proprietor; 
and  that  the  proprietor  is  owed  $8,000  by  the  outside 
parties  (Cash,  Merchandise  and  Bills  Payable)  collectively. 
Now,  the  net  amount  which  the  proprietor  is  owed  by  the 
outside  parties  collectively  is  his  net  capital;  therefore  the 
first  three  entries  show  the  proprietor's  assets  and  liabilities 
and  the  last  one  shows  his  net  capital. 

The  reader  will  observe  that  in  these  entries  there  is  no 
intermediate  party;  the  only  parties  to  the  accounts  are  the 
proprietor  on  the  one  side  and  the  outside  parties,  severally 
and  collectively,  on  the  other  side. 


78 


PBINCIPLBS    OF 


The  common  theory  of  double-entry  bookkeeping  makes 
the  "business"  the  second  party  in  every  account;  therefore, 
according  to  that  theory,  the  entries  to  open  the  books  would  be 
as  follows: 

JOURNAL 

Dr.  Cr. 

Cash,  to  Business (1)     $1,000 

Merchandise,  to  Business (2)     10,000 

Bills  Payable,  to  Business (3)  $3,000 

Proprietor,  to  Business (4)  8,000 


LEDGER 


Dr. 

Cash                   Cr. 
To  Business 

Dr.           Merchandise 
To  Business 

Cr. 

(1) 

$1,000 

(2)   $10,000 

Dr. 

Bills  Payable           Cr. 
To  Business 

Dr.             Proprietor 
To  Business 

Cr. 

(3)     $3,000 

(4) 

$8,000 

These  entries  mean  that  the  person  called  Cash  owes 
$1,000  to  the  business;  that  the  person  called  Merchandise 
owes  $10,000  to  the  business;  that  the  person  called  Bills 
Payable  is  owed  $3,000  by  the  business;  and  that  the  pro- 
prietor is  owed  $8,000  by  the  business.  Therefore  the  first 
two  entries  show  the  assets  of  the  business  and  the  last  two 
show  the  liabilities  of  the  business,  and  assets  and  liabilities 
are  always  equal.  The  reader  will  observe  that  in  this  case 
the  proprietor  has  nothing  to  do  with  any  of  the  accounts 
except  the  last  one. 

In  practice  the  bookkeeper  never  writes  the  name  of  the 
second  party,  and  therefore  he  makes  the  opening  entries  in 
this  form: 


DOUBLE-ENTKY   BOOKKEEPING 


79 


JOURNAL 


Dr. 


Cr. 


Cash    (1)     $1,000 

Merchandise    (2)     10,000 

Bills   Payable (3)  $3,000 

Proprietor    (4)  8,000 

LEDGER 


Dr.                  Cash                   Cr. 

Dr.            Merchandise             Cr. 

(1)     $1,000 

(2)    $10,000 

Dr.          Bills  Payable           Cr. 

Dr.              Proprietor               Cr. 

(3)     $3,000 

. 

(4)     $8,000 

To  explain  the  meaning  of  these  entries  is  the  first  and 
the  fundamental  problem  of  double-entry  bookkeeping.  The 
words  debtor  and  creditor  convey  the  idea  of  owing  and  of 
being  owed,  and  if  a  given  amount  is  owed  it  must  be  owed 
to  one  person  by  another  person.  The  question  therefore  is : 
To  whom  are  owed  the  amounts  entered  as  debits  and  by 
whom  are  owed  the  amounts  entered  as  credits?  In  reply  to 
that  question  the  bookkeeper  says  that  the  amounts  entered 
as  debits  are  owed  to  the  business  and  that  the  amounts 
entered  as  credits  are  owed  by  the  business.  Many  modern 
writers  on  the  subject  recognize  the  absurdity  of  that  answer, 
but  being  unable  to  devise  any  other  answer  to  the  question 
they  declare  that  the  words  debtor  and  creditor,  as  used  here, 
have  no  meaning  at  all,  that  they  are  merely  arbitrary  signs 
to  distinguish  between  the  left-hand  side  and  the  right-hand 
side.  But  that  does  not  solve  the  problem,  it  simply  begs 
the  question;  it  is  equivalent  to  declaring  that  the  entries 
themselves  mean  nothing. 

In  the  case  of  the  problem  involved  in  this  question  there 
are  only  two  possible  theories,  the  theory  of  duplicate  entry 


SO  PRINCIPLES    OF 

developed  in  our  discussion,  which  is  the  true  theory,  and  the 
theory    which    is    commonly    taught — a    theory    which    has 
muddled  the  brains  of  bookkeepers  ever  since  double-entry 
"^      bookkeeping  was  invented. 

According  to  the  theory  of  duplicate  entry  the  entries 
given  above  mean  that  Cash  owes  $1,000  to  the  proprietor, 
that  Merchandise  owes  $10,000  to  the  proprietor,  that  Bills 
payable  is  owed  $3,000  by  the  proprietor, (and  that  the  pro- 
Jprietor  is  owed  $8,000  by  the  outside  parties  (Cash,  Merchan- 
t*,dise  and  Bills  Payable)  collectively^)  In  this  case  the  words 
tf  asset  and  liability  must  be  used  from  the  standpoint  of  the 
V\/   proprietor,  since  every  debt  is  owed  either  to  the  proprietor 
or  by  the  proprietor. 

According  to  the  common  theory  of  double-entry  book- 
keeping  the   entries   mean   that   Cash   owes   $1,000   to   the 
business,  that  Merchandise  owes  $10,000  to  the  business,  that 
j    «    Bills  Payable  is  owed  $3,000  by  the  business  and  that  the 
y  .  /     proprietor  is  owed  $8,000  by  the  business.    In  this  case  the 
words  asset  and  liability  must  be  used  from  the  standpoint 
of  the  business,  since  every  debt  is  owed  either  to  the  busi- 
r^  ness  or  by  the  business. 

From  the  standpoint  of  the  proprietor  assets  and  lia- 
bilities, like  losses  and  gains,  are  almost  invariably  unequal. 
Excess  of  assets  over  liabilities  is  net  asset,  excess  of  liabilities 
over  assets  is  net  liability,  excess  of  losses  over  gains  is  net 
loss,  excess  of  gains  over  losses  is  net  gain. 

From  the  standpoint  of  the  business  assets  and  liabilities, 
as  well  as  losses  and  gains,  are  always  equal,  and  therefore 
there  is  no  such  thing  as  net  asset  or  net  liability  or  net  loss 
or  net  gain. 

In  the  one  case  the  relative  terms  asset  and  liability  are 
used  from  a  single  standpoint,  the-  standpoint  of  a  party 
that  faces  one  way.  In  the  other  case  the  relative  terms 
asset  and  liability  are  used  from  a  double  standpoint,  the 
standpoint  of  a  party  that  faces  both  ways.  The  difference 


i 


DOUBLE-ENTRY   BOOKKEEPING  81 

between  the  two  theories,  then.,  is  simply  the  difference 
between  a"  proper  and  an  improper  use  of  relative  terms. 

In  accordance  with  the  theory  of  duplicate  entry  the 
accountant  says  asset  when  he  means  asset,  liability  when  he 
means  liability  and  net  capital  when  he  means  net  capital. 
In  accordance  with  the  common  theory  of  double-entry 
bookkeeping  the  accountant  says  asset  when  he  means  asset, 
liability  when  he  means  liability,  liability  when  he  means 
net  asset  and  asset  when  he  means  net  liability;  and  if  he 
were  true  to  his  own  theory,  he  would  say  loss  when  he  means 
net  gain  and  gain  when  he  means  net  loss.  In  the  one  case 
the  accountant's  language  is  clear  and  accurate,  while  in  the 
other  case  it  is  confused  and  unintelligible. 

There  may  be  men  whose  minds  are  so  constituted,  or 
so  warped  and  twisted  by  false  training,  that  they  cannot 
appreciate  the  difference  between  the  two  theories,  but  in 
reality  it  is  a  fundamental  difference.  It  is  the  difference 
between  the  right  way  and  the  wrong  way;  it  is  the  differ- 
ence between  clear  thinking  and  muddled  thinking;  it  is  the 
difference  between  rational  speech  and  irrational  speech;  it 
is  the  difference  between  straight-eyed  bookkeeping  and  cross- 
eyed bookkeeping. 

When,  in  accordance  with  the  theory  of  duplicate  entry,  a 
man  says  that  good  debts  owed  to  the  proprietor  by  the  out- 
side parties  severally,  represent  asset,  that  good  debts  owed 
by  the  proprietor  to  the  outside  parties  severally,  represent 
liability,  and  that  the  net  good  debt  owed  to  the  proprietor 
by  the  outside  parties  collectively,  represents  net  capital,  the 
clearness  of  his  view  is  beyond  question.  But  when,  in 
accordance  with  the  common  theory  of  double-entry  bookkeep- 
ing, a  man  says  that  the  item  of  $3,000  in  the  above  example 
(an  item  which  represents  a  liability  of  the  proprietor)  is 
to  be  counted  as  a  liability,  and  that  the  item  of  $8,000  (an 
item  which  represents  the  net  liability  to  the  proprietor) 
is  also  to  be  counted  as  a  liability,  it  is  very  evident  that  his 


82  PTtttfCIPLES    OF 

mental  vision  is  out  of  focus;  he  is  trying  to  look  in  two 
directions  at  the  same  time. 

\Ve^  now  hayethe  answer  to  the  question_which  was  raised 
in  Chapter  II,  namely :  Who  is  the  second  party  inthe  pro- 
prietor's account?  The  anpwer  to  that  question  isiTEe^oTlt- 
-filM  Arties  collect!  velvT;  That  is  a  very  simple  answer  to 
a  very  simple  question,  yet  simple  as  the  question  is,  I  believe 
that  the  reader  may  search  the  literature  of  accounting  from 
beginning  to  end  without  finding  a  correct  answer  to  it.  As 
a  matter  of  fact  and  of  record,  that  simple  question  has  been 
a  stumbling-block  to  the  whole  accounting  fraternity  for 
over  four  hundred  years. 

Double-entry  bookkeeping  is  supposed  to  have  been 
invented  at  a  time  when  the  great  majority  of  people  believed 
that  the  earth  is  flat,  and  about  at  the  time  when  Columbus 
started  on  his  voyage  to  prove  his  theory  that  the  earth  is 
round.  Accountants  in  common  with  other  people  have 
abandoned  the  idea  that  the  earth  is  flat;  but  the  universal 
custom  of  making  statements  in  a  form  showing  assets  and 
liabilities  equal  is  conclusive  evidence  that  they  still  cling 
to  the  equally  absurd  idea  that  double-entry  bookkeeping 
deals  with  the  assets  and  liabilities  of  an  imaginary  inter- 
mediate party.  Now  in  all  other  matters  accountants  are 
usually  men  of  very  good  sense,  and  one  would  suppose  that 
they  would  have  intelligence  enough  to  know  that  when  they 
use  the  words  asset  and  liability  from  the  standpoint  of  a 
party  that  faces  both  ways  they  wipe  out  the  idea  of  asset  and 
liability  altogether.  Assets  and  liabilities  which  are  neces- 
sarily equal  are  not  assets  or  liabilities  at  all.  To  talk  about 
the  assets  and  liabilities  of  the  "business"  is  nonsense. 


DOUBLE-ENTRY   BOOKKEEPING  83 

CHAPTER    X 

CLOSING  THE  BOOKS — EXAMPLES  ILLUSTRATING  THE  PROCESS. 

In  the  preceding  chapters  we  have  explained  the  method 
of  opening  the  books  and  of  recording  contributions,  with- 
drawals and  transactions;  it  remains,  therefore,  to  explain 
how  the  books  are  closed. 

The  object  of  closing  the  books  is  to  see  how  we  would 
stand  if  we  realized  all  our  assets  and  settled  all  our  lia- 
bilities. In  order  to  record  this  in  the  ledger  we  must 
pretend  that  all  debts  are  paid,  as  far  as  they  ever  will  be 
paid.  If  the  books  show  that  a  certain  party  owes  us,  then, 
to  the  extent  to  which  the  debt  is  good,  we  credit  him  on  the 
old  account,  as  if  he  had  paid  it,  and  debit  him  on  new 
account.  If  an  account  shows  that  we  owe  the  other  party, 
then,  to  the  extent  to  which  the  debt  is  good,  we  debit  him 
on  the  old  account,  as  if  we  had  paid  it,  and  credit  him  on 
new  account. 

In  this  connection  one  should  note  the  difference  between 
ordinary  language  and  bookkeeping  language.  In  ordinary 
language  we  speak  of  paying  a  debt,  thereby  conveying  the 
idea  that  the  debt  ceases  to  exist ;  but  the  bookkeeping  view  is 
that  debts  never  cease  to  exist,  although  they  may  be  neutral- 
ized by  equal  and  opposite  debts.  In  double-entry  bookkeep- 
ing every  operation  which  is  recorded  is  a  matter  of  borrowing 
or  lending;  there  is  no  such  thing  as  paying  a  debt.  If 
Smith  settles  a  debt  which  he  owes  us,  then,  in  ordinary 
language  we  say  that  he  pays  the  debt;  but  in  bookkeeping 
language  we  do  not  say  that  he  pays  the  debt,  we  say  that  we 
borrow  an  equal  amount  from  Smith,  and  then  the  debt  which 
we  owe  him  cancels  the  debt  which  he  owes  us.  If  we  settle 
a  debt  which  we  owe  Jones,  then,  in  ordinary  language  we 
say  that  we  pay  the  debt;  but  in  bookkeeping  language  we  do 


84  PRINCIPLES    OP 

not  say  that  we  pay  the  debt,  we  say  that  we  lend  an  equal 
amount  to  Jones,  and  then  the  debt  which  he  owes  us  cancels 
the  debt  which  we  owe  him. 

In  bookkeeping  language,  then,  we  would  state  the  case 
as  follows:  If  at  the  time  of  closing  the  books  an  account 
shows  that  the  other  party  owes  us,  then,  to  the  extent  to 
which  the  debt  is  good,  we  borrow  the  amount  from  him  on 
old  account  and  lend  it  to  him  on  new  account.  If  an  account 
shows  that  we  owe  the  other  party,  then,  to  the  extent  to 
which  the  debt  is  good,  we  lend  the  amount  to  him  on  old 
account  and  borrow  it  from  him  on  new  account.  That  is 
the  way  in  which  bookkeeping  language  expresses  the  idea 
that  at  the  time  of  closing  the  books  all  debts  are  supposed 
to  be  paid,  as  far  as  they  ever  will  be  paid. 

The  amount  entered  in  such  a  case  is  not  necessarily  the 
amount  of  the  debt,  it  is  the  amount  which  we  think  will 
be  paid;  therefore,  to  close  the  books  we  must  appraise  the 
values  of  all  debts.  Now  to  appraise  the  values  of  debts 
is  exactly  the  same  thing  in  principle  as  to  appraise  the 
value  of  a  stock  of  merchandise  or  a  piece  of  real  estate; 
it  is  a  matter  of  judgment.  When  we  appraise  the  value 
of  a  stock  of  goods  we  call  it  "taking  inventory" ;  but  the  idea 
of  "inventory"  is  not  confined  to  merchandise;  in  its  broader 
sense,  to  take  inventory  means  to  appraise  the  values  of  the 
assets  and  liabilities  existing  at  a  given  time.  It  is  in  that 
sense  that  the  expression  is  used  in  bookkeeping,  and  in  that 
sense  it  applies  to  every  account  of  original  entry  and  to  the 
principal  account  of  duplicate  entry,  net  capital  account; 
they  are  all  closed  by  inventory.  The  subordinate  accounts  of 
duplicate  entry  (partnership  accounts  and  accounts  like 
Capital  Stock  and  Surplus)  cannot  be  closed  directly  by 
inventory,  since  there  are  no  particular  assets  or  liabilities 
corresponding  to  these  accounts;  but  the  total  amount  of  the 
net  capital  is  determined  by  inventory,  and  this  total  c'an  be 
distributed  among  the  various  subordinate  accounts. 


DOUBLE-ENTRY    BOOKKEEPING  85 

The  arithmetical  balance  of  an  account  is  the  difference 
between  the  two  sides;  the  inventory  balance  is  the  appraised 
value  of  the  asset  or  liability  (or  net  asset  or  net  liability) 
remaining.  When  we  say  that  an  account  is  closed  by  balance, 
we  mean  that  it  is  closed  by  arithmetical  balance;  when  we 
say  that  an  account  is  closed  by  inventory,  we  mean  that  it  is 
closed  by  inventory  balance.  The  ledger  account  as  a  record 
of  debt  is  closed  by  balance;  as  a  record  of  asset  and  liability 
it  is  closed  by  inventory. 

In  the  expression  inventory  balance  the  word  balance  has  \ 
lost  its  original  meaning  altogether;  it  does  not  mean 
balance,  it  means  remainder.  In  merchandise  account,  for 
example,  the  amount  which  the  bookkeeper  enters  under  the 
head  of  "balance"  is  not  the  balance  of  the  account;  it  is 
the  balance,  or  remainder,  of  the  merchandise  as  determined 
by  inventory.  The  origin  of  this  confusing  use  of  the  word 
balance  is  evident.  To  balance  an  account  the  total  of  the 
smaller  side  is  subtracted  from  the  total  of  the  larger  side, 
and  the  remainder  is  the  amount  which  must  be  added  to  - 
the  smaller  side  to  make  the  account  balance.  The  fact  that 
he  applies  the  word  balance  to  the  remainder  of  an  account 
has  led  the  bookkeeper  to  apply  the  same  term  to  any  and 
every  remainder.  The  amount  which  is  carried  down  to  new 
account  is  the  remainder  of  the  asset  or  liability,  that  is  to 
say,  it  is  the  asset  or  liability  remaining;  this  may  or  may 
not  be  the  remainder  of  the  account,  but  whether  it  is  or 
not,  the  bookkeeper  always  calls  it  the  "balance."  The  "bal- 
ance," then,  does  not  always  balance  the  account,  and  if  it 
does  not,  the  difference  represents  loss  or  gain  (or  net  loss  / 
or  net  gain).  / 

The  reason  why  the  difference  must  represent  loss  or  gain 
is  evident.  The  only  operations  with  which  double-entry  book- 
keeping concerns  itself  are  matters  of  borrowing  and  lending, 
and  the  purpose  of  the  accounts  is  to  record  the  debts  result- 
ing from  these  operations;  and  in  borrowing  and  lending 


86  PRINCIPLES    OF 

there  can  be  no  loss  nor  gain  as  long  as  the  debts  are  good. 
It  follows,  therefore,  that  in  this  system  of  accounting  the 
books  are  kept  in  such  a  way  that  the  net  debits  and  net 
credits  of  the  ledger  accounts  always  show  what  the  assets, 
liabilities  and  net  capital  would  be  if  there  were  no  loss 
nor  gain.  If  then,  in  any  given  case,  the  amount  of  the 
asset  or  liability  (or  net  asset  or  net  liability)  as  determined 
by  inventory  does  not  agree  with  the  balance  of  the  account, 
the  difference  represents  the  loss  or  gain  (or  net  loss  or  net 
gain). 

To  illustrate  the  method  of  closing  the  accounts  in  double- 
entry  bookkeeping  we  will  assume  that  at  the  end  of  the 
period  interest  account  is  as  follows : 

Dr.  Interest  Cr. 

To  Proprietor 


$120 

80 

170 

130 


$90 

140 

55 

115 


This  account  means  that  the  proprietor  has  paid  out 
$500  (the  total  of  the  debit  side)  for  interest  on  debts  owed 
by  him,  and  has  received  $400  (the  total  of  the  credit  side) 
for  interest  on  debts  owed  to  him. 

That  is  the  meaning  of  the  account  expressed  in  literal 
language;  but  in  the  figurative  language  of  double-entry 
bookkeeping  the  account  means,  and  says,  that  the  proprietor 
has  lent  $500  to  the  person  called  Interest  and  has  bor- 
rowed $400  from  him.  In  other  words,  the  account  says 
that  the  person  called  Interest  owes  $500  to  the  proprietor 
and  is  owed  $400  by  the  proprietor,  which  is  equivalent  to 
saying  that  he  owes  the  proprietor  $100.  The  account  shows 


DOUBLE-ENTRY   BOOKKEEPING 


87 


the  amount  of  the  debt,  but  the  amount  which  will  be  paid 
can  be  determined  only  by  inventory. 

In  closing  the  above  account  there  are  many  possible 
cases,  some  of  which  are  illustrated  by  the  following  examples : 

Case  I.  The  inventory  shows  unpaid  (but  good)  accrued 
interest  receivable  to  the  amount  of  $70. 

The  amount  of  the  accrued  interest  receivable  is  the 
amount  which  the  person  called  Interest  will  pay  on  his  debt 
of  $100,  and  in  order  to  close  the  account  we  must  pretend 
that  he  has  paid  it;  we  therefore  credit  him  with  the  $70  on 
old  account  and  debit  him  on  new  account.  The  account  then 
takes  this  form: 

Dr.  Interest  Cr. 

To  Proprietor 


$120 
80 
170 
130 

$90 
140 
55 
115 
Bal.    (Accr'd   Int.   Rec.)     .     70 

Total    Credits  $470 
Excess  Debit    (Loss)    30 

Total   Debits    $500 

$500 

Bal.    (Accr'd  Int.  Rec.)    .     $70 

Our  discussion  now  deals  only  with  the  old  account  and 
the  reader  will  note  that  we  are  supposed  to  have  received 
the  item  of  $70  which  is  entered  in  that  account  as  represent- 
ing the  remainder  of  the  accrued  interest  receivable.  To  be 
sure,  we  have  given  it  out  again  on  new  account,  but  that 
does  not  affect  the  preceding  period. 

The  argument  to  prove  that  the  excess  debit  ($30)  repre- 
sents loss  may  be  stated  in  four  different  forms,  as  follows: 

1.  In  every  account  of  original  entry,  that  is  to  say,  in 
every  account  in  which  we  (the  proprietor)  are  the  second 
party,  debits  record  the  amounts  which  we  have  given  to  the 
person  whose  name  heads  the  account,  and  credits  record  the 


88  PRINCIPLES    OF 

amounts  which  we  have  received  from  him.  Therefore  the 
above  account  shows  that  we  have  given  $500  to  the  person 
called  Interest  and  have  received  $470  from  him.  Since  we 
will  receive  nothing  more  on  this  account  we  have  suffered 
a  loss  of  $30. 

2.  When  a  person  borrows  from  us  he  causes  outgo  and 
when  he  lends  to  us  he  causes  income.    Debits  to  his  account, 
then,  indicate  that  he  has  caused  outgo  and  credits  indicate 
that  he  has  caused  income.    Therefore  the  above  account  shows 
that  the  person  called  Interest  has  caused  outgo  to  the  amount 
of  $500  and  income  to  the  amount  of  $470;  he  has  caused  a 
loss  of  $30. 

3.  At  the  close  of  the  period  the  account  shows  that 
there  would  be  an  asset  of  $100,  if  there  were  no  loss  nor 
gain,  and  the  inventory  shows  that  there  is  an  asset  of  $70; 
therefore  the  difference  ($30)  represents  loss. 

4.  At  the  close  of  the  period  the  account  shows  that  the 
person  called  Interest  owes  us  $100.    To  the  extent  to  which 
the  debt  is  good  ($70),  it  represents  asset;  to  the  extent  to 
which  it  is  bad  ($30),  it  represents  loss. 

This  example  illustrates  the  confusing  use  of  the  word 
balance.  The  bookkeeper  always  applies  that  term  to  the 
amount  which  is  carried  down  to  new  account ;  but  as  a  matter 
*of  fact,  in  this  case  the  balance  of  the  account,  before  the 
amount  of  the  accrued  interest  receivable  has  been  entered, 
is  $100,  and  after  the  amount  of  the  accrued  interest  receiv- 
able has  been  entered,  the  balance  of  the  account  is  $30.  This 
balance  of  $30  is  not  a  part  of  the  account,  it  is  the  result 
of  the  account;  it  is  not  a  part  of  the  credit  side  of  the 
account,  it  is  the  excess  of  the  debit  side  over  the  credit  side. 
For  that  reason  the  bookkeeper  always  enters  it  in  red  ink. 

The  bookkeeper  also  enters  the  inventory  balance  ($70) 
in  red  ink  in  the  old  account,  but  for  a  different  reason. 
We  have  not  actually  received  the  $70,  but  we  pretend  that 
we  have  received  it  in  order  to  close  the  account.  We  pre- 


DOUBLE-ENTRY   BOOKKEEPING 


89 


tend  that  we  borrow  the  $70  from  the  person  called  Interest, 
on  old  account,  and  lend  it  to  him  on  new  account;  therefore 
the  amount  is  entered  as  a  liability  in  the  old  account  and 
as  an  asset  in  the  new  account.  Since  it  is  only  a  pretended 
liability,  it  is  entered  in  red  in  the  old  account;  but  it  is  an 
actual  asset,  and  therefore  it  is  entered  in  black  in  the  new 
account. 

Case  II.  The  inventory  shows  that  there  is  an  asset  of 
$145  in  the  form  of  accrued  interest  receivable. 

The  account  then  ta^es  this  form: 


Dr. 


Interest 

To  Proprietor 


Cr. 


$120 

$90 

80 

140 

170 

55 

130 

115 



Bal.  (Accr'd  Int.  Rec.)  ..  145 

Total  Debits  . 

...  $500 

Excess  Credit  (Gain) 

45 

$545 

Total  Credits  $545 

Bal. 

(Accr'd  Int.  Rec.) 

..  $145 

In  this  case  the  four  forms  of  the  argument  are  as  follows : 

1.  We  have  given  $500  to  the  person  called  Interest  and 
have  received  $545   from  him,  therefore  we  have  made  a 
gain  of  $45. 

2.  The  person  called  Interest  has  caused  outgo  to  the 
amount  of  $500  and  income  to  the  amount  of  $545,  therefore 
he  has  caused  a  gain  of  $45. 

3.  At  the  close  of  the  period  the  account  shows  that 
there  would  be  an  asset  of  $100  if  there  were  no  loss  nor 
gain,  and  the  inventory  shows  that  there  is  an  asset  of  $145 ; 
therefore  the  difference  ($45)  represents  gain. 

4.  At  the  close  of  the  period  the  account  shows  that 
the  person  called  Interest  owes  us  $100.     To  the  extent  to 


90 


PRINCIPLES    OF 


which  the  debt  is  good  ($145),  it  represents  asset;  to  the 
extent  to  which  it  is  bad  ($45).  it  represents  gain.  To  say 
that  the  person  called  Interest  owes  us  $100  is  equivalent  to 
saying  that  he  owes  us  $145  and  we  owe  him  $45.  The  debt 
of  $145  which  he  owes  us  is  good,  it  represents  asset;  the 
debt  of  $45  which  we  owe  him  is  bad,  it  represents  gain. 

Case  III.  The  inventory  shows  that  there  is  a  liability 
of  $50  in  the  form  of  accrued  interest  payable. 

In  this  case,  instead  of  Interest  paying  us  $100,  we  must 
pay  Interest  $50.  Therefore,  to  close  the  account  we  debit 
the  person  called  Interest  with  the  $50  on  old  account,  as 
if  we  had  paid  it,  and  credit  him  on  new  account;  in  other 
words,  we  lend  the  $50  to  him  on  old  account  and  borrow  it 
from  him  on  new  account.  The  account  then  takes  this  form: 


Dr. 


Interest 

To  Proprietor 


Cr. 


$120 

$90 

80 

140 

170 

55 

130 

115 

Bal.  (Accr'd  Int.  Pay.)  ..  50 

Total  Credits  ..... 

$400 

Excess  Debit  (Loss)  .  .  . 

150 

Total  Debits  $550 

$550 

Bal.  (Accr'd  Int.  Pay.)  .. 

$50 

Here  the  four  forms  of  the  argument  are  as  follows: 

1.  We  have  given  $550  to  the  person  called  Interest  and 
have  received  $400  from  him,  therefore  we  have  suffered  a 
loss  of  $150. 

2.  The  person  called  Interest  has  caused  outgo  to  the 
amount  of  $550  and  income  to  the  amount  of  $400,  therefore 
he  has  caused  a  loss  of  $150. 

3.  At  the  end  of  the  period  the  account  shows  that  there 
would  be  an  asset  of  $100  if  there  were  no  loss  nor  gain,  and 


DOUBLE-ENTKY    BOOKKEEPING 


91 


the  inventory  shows  that  there  is  a  liability  of  $50;  therefore 
the  difference  ($150)  represents  loss. 

4.  At  the  close  of  the  period  the  account  shows  that  the 
person  called  Interest  owes  us  $100.  To  the  extent  to  which 
the  debt  is  good  ($50),  it  represents  liability;  to  the  extent  to 
which  it  is  bad  ($150),  it  represents  loss.  To  say  that  the 
person  called  Interest  owes  us  $100  is  equivalent  to  saying 
that  he  owes  us  $150  and  we  owe  him  $50.  The  debt  of  $50 
which  we  owe  him  is  good,  it  represents  liability ;  the  debt  of 
$150  which  he  owes  us  is  bad,  it  represents  loss. 

Case  IV.  The  inventory  shows  that  there  is  an  asset  of 
$70  in  the  form  of  accrued  interest  receivable  and  a  liability 
of  $50  in  the  form  of  accrued  interest  payable. 

The  amount  of  the  asset  ($70)  is  entered  as  a  credit  in 
the  old  account  and  as  a  debit  in  the  new  account,  and  the 
amount  of  the  liability  ($50)  is  entered  as  a  debit  in  the 
old  account  and  as  a  credit  in  the  new  account.  In  other 
words,  we  borrow  the  amount  of  the  asset  from  the  person 
called  Interest,  on  old  account,  and  lend  it  to  him  on  new 
account,  and  we  lend  him  the  amount  of  the  liability,  on  old 
account,  and  borrow  it  from  him  on  new  account.  The 
account  then  takes  this  form : 

Dr.  Interest  Cr. 

To  Proprietor 


$120 

$90 

80 

140 

170 

55 

130 

115 

Bal. 

(Accr'd 

Int.  Pay.) 

.  .   50 

Bal.  (Accr'd 

Int.  Rec.)  . 

70 

Total  ( 

Credits 

$470 

Excess  Debit 

(Loss)  ... 

80 

Total 

Debits  .  .  . 

.  $550 

$550 

Bal. 

(Accr'd 

Int.  Rec.) 

.  $70 

Bal.  (Accr'd 

Int.  Pay.).. 

$50 

In  this  case  the  four  forms  of  the  argument  are  as  follows : 
1.     We  have  given  $550  to  the  person  called  Interest  and 


92  PKINCIPLES    OF 

have  received  $470  from  him,  therefore  we  have  suffered  a 
loss  of  $80. 

2.  The  person  called  Interest  has  caused  outgo  to  the 
amount  of  $550  and  income  to  the  amount  of  $470,  there- 
fore he  has  caused  a  loss  of  $80. 

3.  At  the  end  of  the  period  the  account  shows  that  there 
would  be  an  asset  of  $100  if  there  were  no  loss  nor  gain, 
and  the  inventory  shows  that  there  is  a  net  asset  of  $20 
(an  asset  of  $70  and  a  liability  of/$50) ;  therefore  the  differ- 
ence ($80)  represents  loss. 

4.  At  the  end  of  the  period  the  account  shows  that 
Interest  owes  us  $100.    To  say  that  the  person  called  Interest 
owes  us  $100  is  equivalent  to  saying  that  he  owes  us  $150 
and  we  owe  him  $50.    The  debt  of  $50  which  we  owe  him  is 
good,  it  represents  liability.     The  debt  of  $150  which  he 
owes  us,  to  the  extent  to  which  it  is  good  ($70),  represents 
asset;  to  the  extent  to  which  it  is  bad  ($80),  it  represents  loss. 

Here,  again,  the  reader  will  observe  that  the  word  balance, 
as  used  in  the  above  example,  does  not  mean  the  balance  of 
the  account.  The  $50  is  the  balance,  that  is  to  say,  the 
unpaid  remainder,  of  the  accrued  interest  payable,  and  the 
$70  is  the  unpaid  remainder  of  the  accrued  interest  receivable. 

In  practice,  the  bookkeeper  does  not  use  the  forms  illus- 
trated above.  He  transfers  the  balance  of  the  accrued  interest 
receivable  to  Interest  Keceivable  and  the  balance  of  the 
accrued  interest  payable  to  Interest  Payable,  thus  closing 
Interest  without  carrying  anything  down  to  new  account 
under  that  heading.  In  practice,  then,  he  uses  three  accounts 
to  carry  the  record  pertaining  to  the  subject  of  interest. 
But  whether  to  carry  the  record  in  one  account  or  in  three  is 
merely  a  question  of  convenience;  it  does  not  involve  any 
principle  of  double-entry  bookkeeping. 

As  a  matter  of  fact,  the  method  illustrated  above  is  more 
convenient  than  the  one  which  is  used  in  practice.  When 
the  bookkeeper  transfers  the  balance  of  the  accrued  interest 


DOUBLE-ENTRY    BOOKKEEPING  93 

receivable  to  one  account  and  the  balance  of  the  accrued 
interest  payable  to  another,  he  makes  his  work  more  difficult, 
because  he  must  keep  constantly  in  mind  the  items  which 
compose  those  amounts,  in  order  to  be  able  to  make  the 
entries  in  the  proper  accounts  when  any  of  the  items  are 
paid.  But  when  the  account  is  kept  in  the  manner  illustrated 
above,  there  is  no  need  of  carrying  the  items  in  mind,  since 
all  entries  pertaining  to  the  subject  of  interest  are  made  in 
the  current  interest  account. 

Case  V.  The  inventory  shows  that  there  is  no  asset  nor 
liability. 

The  account  then  is  in  this  form : 

Dr.  Interest  Cr. 

To   Proprietor 


$120 
80 
170 
130 

$90 
140 
55 
115 

Total  Credits  $400 
Excess  Debit  (Loss)  ...  100 

Total  Debits  $500 

$500 

In  this  case  the  four  forms  of  the  argument  are  as  follows : 

1.  We  have  given  $500  to  the  person  called  Interest  and 
have  received  $400  from  him,  therefore  we  have  suffered  a 
loss  of  $100. 

2.  The  person  called  Interest  has  caused  outgo  to  the 
amount  of  $500  and  income  to  the  amount  of  $400,  therefore 
he  has  caused  a  loss  of  $100. 

3.  At  the  close  of  the  period  the  account  shows  that  there 
would  be  an  asset  of  $100  if  there  were  no  loss  nor  gain,  and 
the  inventory  shows  that  there  is  no  asset;  therefore  the  differ- 
ence ($100)  represents  loss. 

4.  At  the  close  of  the  period  the  account  shows  that  the 
person  called  Interest  owes  us  $100.     This  debt  is  bad  and 
therefore  it  represents  loss. 


94  PRINCIPLES    OF 

In  the  above  discussion  we  have  used  interest  account 
as  an  illustration,  but  the  discussion  is  general  in  its  nature. 
It  applies  to  all  personal  accounts,  to  Bills  Receivable,  to  Bills 
Payable,  to  all  property  accounts,  like  Cash,  Merchandise 
and  Real  Estate,  and  to  all  accounts  representing  causes  of 
outgo  and  income,  like  Interest  and  Expense.  Every  account 
of  original  entry  is  closed  by  inventory.  If  the  inventory 
shows  that  there  is  an  asset  remaining,  the  amount  is  entered 
as  a  credit  in  the  old  account  and  as  a  debit  in  the  new 
account;  if  the  inventory  shows  that  there  is  a  liability 
remaining,  the  amount  is  entered  as  a  debit  in  the  old  account 
and  as  a  credit  in  the  new  account.  After  these  entries  have 
been  made,  an  excess  debit  represents  loss,  an  excess  credit 
represents  gain. 

The  account  of  duplicate  entry,  net  capital  account,  is 
also  closed  by  inventory;  but  in  this  account,  as  compared 
with  the  accounts  of  original  entry,  the  relative  position  of 
the  proprietor  and  the  outside  parties  is  reversed,  and  there- 
fore the  manner  of  making  the  entries  is  reversed  and  the 
meaning  of  an  excess  of  one  side  over  the  other  is  reversed. 
If  the  inventory  shows  an  excess  of  assets  over  liabilities,  the 
amount  of  the  net  asset  is  entered  as  a  debit  in  the  old 
account  and  as  a  credit  in  the  new  account;  if  the  inventory 
shows  an  excess  of  liabilities  over  assets,  the  amount  of  the 
net  liability  is  entered  as  a  credit  in  the  old  account  and  as 
a  debit  in  the  new  account.  After  these  entries  have  been 
made,  an  excess  debit  represents  the  net  gain,  an  excess 
credit  represents  the  net  loss. 

When  net  capital  account  is  omitted  and  its  subdivisions 
(partnership  accounts  and  accounts  like  Capital  Stock  and 
Surplus)  are  carried  in  its  place,  the  only  difference  is  that 
the  net  asset  or  net  liability,  instead  of  being  entered  in  one 
account,  is  distributed  among  the  various  accounts  of  dupli- 
cate entry. 


DOUBLE-ENTRY    BOOKKEEPING  95 

CHAPTER    XI 

THE  OBJECT  OF  KEEPING  ACCOUNTS. 

In  keeping  their  accounts  (using  that  expression  to  mean 
the  continuous  process  of  keeping  the  books  as  distinguished 
from  the  act  of  closing  them)  bookkeepers  have  very  vague 
ideas  as  to  what  they  are  trying  to  do.  As  a  matter  of  fact, 
they  do  not  even  know  what  they  keep  accounts  for. 

Most  of  the  text-book  writers  evidently  think  that  we 
keep  some  accounts  to  show  what  the  assets  and  liabilities 
are,  and  other  accounts  to  show  what  the  losses  and  gains 
are.  They  think  that  personal  accounts  and  accounts  like 
Cash,  Merchandise  and  Real  Estate  are  asset-and-liability 
accounts,  and  that  accounts  like  Interest  and  Expense  are 
loss-and-gain  accounts;  and  they  think  that  the  loss-and-gain 
accounts  are  subdivisions  of  the  proprietor's  account. 

Now  all  bookkeepers  know  that  in  many  cases  both  an 
asset  or  a  liability  and  a  loss  or  a  gain  are  recorded  under 
the  same  heading,  constituting  what  some  of  the  writers  call 

mixed"  account.  They  know,  for  example,  that  in  the 
case  of  a  personal  account,  a  balance  owed  to  the  pro- 
prietor may  represent  asset,  or  it  may  represent  loss,  or 
part  of  it  may  represent  asset  and  the  rest  of  it  repre- 
sent loss.  The  personal  account,  then,  which  is  the  very 
type  and  pattern  of  all  ledger  accounts,  is  or  may  be 
a  "mixed"  account.  Yet  in  spite  of  that  fact,  which  in 
itself  is  conclusive  evidence  that  their  classification  is  false, 
the  text-books  try  to  divide  all  accounts  into  the  two  kinds, 
and  they  give  them  various  names.  They  call  them  balance- 
sheet  accounts  and  profit-and-loss  accounts,  or  they  call 
them  primary  accounts  and  secondary  accounts,  or  they  call 
them  real  accounts  and  nominal  accounts,  or  they  call  them 
true  accounts  and  representative  accounts,  or  they  call  them 


96  PKINCIPLES    OF 

financial  accounts  and  business  accounts,  or  they  call  them 
specific  accounts  and  economic  accounts.  But  whatever  names 
they  may  use,  the  underlying  idea  is  that  we  keep  some 
accounts  to  show  what  the  assets  and  liabilities  are,  and  other 
accounts  to  show  what  the  losses  and  gains  are. 

That  idea,  like  the  idea  of  a  reversal  in  the  rule  for 
debiting  and  crediting,  is  entirely  wrong.  We  do  not  keep 
accounts  to  show  what  the  assets  and  liabilities  are,  nor  to 
show  what  the  losses  and  gains  are;  we  keep  accounts  to 
show  what  the  assets,  liabilities  and  net  capital  would  be  if 
there  were  no  gain  nor  loss.  What  the  assets,  liabilities  and 
net  capital  are,  is  determined  by  inventory,  and  the  differ- 
ences between  what  they  are  and  what  they  would  be  if 
there  were  no  gain  nor  loss,  represent  the  gains  and  losses 
and  the  net  gain  or  net  loss. 

The  bookkeeper  will  readily  understand  the  purpose  for 
which  accounts  are  kept,  if  he  will  consider  for  a  moment  the 
fact  that  his  so-called  "trial  balance,"  when  he  enters  the 
net  debits  on  the  one  side  and  the  net  credits  on  the  other 
side,  is  simply  a  statement  showing  what  the  assets,  liabilities 
and  net  capital  would  be  at  that  time,  if  there  were  no  loss 
nor  gain.  Now  the  whole  object,  and  the  only  object,  of 
keeping  the  books  (as  distinguished  from  the  act  of  closing 
them)  is  to  supply  the  information  which  is  contained  in 
that  statement.  Moreover,  that  is  the  limit  of  possibility 
in  the  art  of  accounting,  and  that  fact  explains  why  account- 
ing is  not  an  exact  science.  Assuming  that  the  entries  which 
were  made  to  open  the  books  are  correct,  we  can  keep  accounts 
to  show  with  absolute  accuracy  what  the  assets,  liabilities 
and  net  capital  would  be  at  any  given  time,  if  there  were 
no  loss  nor  gain.  But  there  is  no  exact  method  of  determin- 
ing what  the  assets,  liabilities  and  net  capital  are;  the  only 
way  to  determine  it  at  all  is  by  inventory;  and  that  at  best 
is  merely  an  approximation,  a  matter  of  judgment  and  of 
estimate. 


DOUBLE-ENTRY    BOOKKEEPING  97 

has  given  the  bookkeeper  the  idea  that  he  keeps 
some  accounts  to  show  what  the  assets  and  liabilities  are  and 
other  accounts  to  show  what  the  losses  and  gains  are,  is  the 
fact  that  in  some  accounts  most  of  the  entries  record  good 
debts,  and  in  other  accounts  most  of  the  entries  record  bad 
debts.  In  the  books  of  railroad  and  industrial  corporations, 
for  example,  it  is  customary  to  have  a  general  class  of  accounts 
called  "construction  accounts/'  and  another  general  class  of 
accounts  called  "operating  accounts";  and,  as  a  rule,  only 
good  debts  are  entered  in  construction  accounts  and  only  bad 
debts  are  entered  in  operating  accounts.  In  other  words, 
the  balance  of  a  construction  account  is  generally  regarded 
as  representing  an  asset,  and  the  balance  of  an  operating 
account  is  generally  regarded  as  representing  a  loss  or  a  gain. 
In  closing  such  accounts  the  bookkeeper  follows  a  certain 
routine  and  does  not  consciously  go  through  the  process  of 
taking  inventory,  and  that  has  given  him  the  impression  that 
the  accounts  themselves  show  what  the  assets  and  liabilities 
and  the  losses  and  gains  are,  without  the  necessity  of  taking 
inventory. 

That  idea  is  wrong.  The  best  that  can  be  clone  in  account- 
ing, and  all  that  can  be  done,  is  to  keep  accounts  to  show  what 
the  assets  and  liabilities  would  be  if  there  were  no  loss  nor 
gain.  Knowing  in  each  case  what  the  asset  or  liability  would 
be  if  there  were  no  loss  nor  gain,  we  are  in  a  position  to 
determine,  with  reasonable  accuracy,  what  the  asset  or  lia- 
bility (and  therefore  the  loss  or  gain)  is.  But  in  every 
case  the  amount  must  be  determined  by  inventory,  that  is  to 
say,  by  appraising  the  value  of  the  debt. 

When  the  bookkeeper  keeps  an  account  to  show  the  cost 
of  constructing  a  certain  portion  of  the  plant,  a  building  for 
example,  he  seems  to  think  that  he  is  keeping  an  account 
to  show  what  the  building  is  worth;  but,  as  a  matter  of  fact, 
he  is  doing  nothing  of  the  kind.  He  is  keeping  an  account 
to  show  what  the  building  would  be  worth  if  it  represented 


98  PRINCIPLES    OF 

the  exact  equivalent  of  every  dollar  that  was  spent  on  it;  in 
other  words,  he  is  keeping  an  account  to  show  what  the  build- 
ing would  be  worth  if  there  were  no  loss  nor  gain.  When 
at  the  time  of  closing  the  account  he  estimates  the  value  of 
the  building,  no  matter  whether  his  estimate  be  the  same 
as  the  cost  or  greater  or  less  than  the  cost,  he  is  taking 
inventory;  and  the  difference,  if  any,  between  the  amount 
determined  by  inventory  and  the  balance  of  the  account,  repre- 
sents the  gain  or  loss. 

When  the  bookkeeper  makes  entries  in  his  expense  account 
he  seems  to  think  that  he  is  keeping  an  account  to  show  the 
loss  caused  by  expense;  but  as  a  matter  of  fact,  he  is  doing 
nothing  of  the  kind.  He  is  keeping  an  account  to  show  what 
the  asset  would  be  if  he  had  on  hand  the  exact  equivalent  of 
every  dollar  recorded ;  in  other  words,  he  is  keeping  an  account 
to  show  what  the  asset  under  that  heading  would  be  if  there 
were  no  loss  nor  gain.  When  at  the  time  of  closing  the 
account  he  decides  that  there  is  an  asset  (prepaid  expense), 
or  that  there  is  a  liability  (unpaid  expense),  or  that  there  is 
no  asset  nor  liability,  he  is  taking  inventory;  and  the  differ- 
ence between  the  amount  determined  by  inventory  and  the 
balance  of  the  account,  represents  the  gain  or  loss. 

The  object  of  keeping  books  is  well  illustrated  by  cash 
account,  an  account  which  is  familiar  to  the  great  majority 
of  people,  since  almost  every  person  at  one  time  or  another 
keeps  track  of  his  own  receipts  and  disbursements  of  cash. 
To  keep  this  account  a  man  does  not  need  any  technical 
knowledge  of  bookkeeping;  it  is  simply  a  matter  of  common 
sense.  In  one  place  he  records  the  cash  which  he  has  on 
hand  at  the  beginning  and  any  subsequent  receipts,  and  in 
another  place,  or  in  another  column,  he  records  the  disburse- 
ments. Now  when  he  does  that  he  is  not  keeping  an  account 
to  show  how  much  cash  he  has  on  hand;  he  is  keeping  an 
account  to  show  how  much  he  ought  to  have  on  hand.  To 
speak  of  a  man  keeping  an  account  to  show  how  much  cash 


DOUBLE-ENTRY   BOOKKEEPING  99 

he  has  on  hand  is  an  absurdity;  the  only  way  to  determine 
how  much  cash  he  has  on  hand  is  to  count  it,  or  in  other 
words,  to  take  inventory  of  it. 

When  a  person  keeps  account  of  his  cash,  he  always  does 
so  (whether  conscious  of  it  or  not)  with  the  idea  that  the 
entries  on  the  one  side  represent  the  receipts  for  which  he 
has  given  an  equivalent,  and  the  entries  on  the  other  side 
represent  the  disbursements  for  which  he  has  received  an 
equivalent.  Therefore,  if  the  amount  of  cash  which  he  has 
on  hand  at  any  given  time  is  greater  or  less  than  the  bal- 
ance of  the  account,  it  shows  (assuming  the  account  to  be 
correct)  that  he  has  received  some  money  without  giving 
an  equivalent  or  has  parted  with  some  money  without  receiv- 
ing an  equivalent;  in  other  words,  it  shows  that  he  has  made 
a  gain  or  has  suffered  a  loss. 

The  point  to  be  observed  is  this:  When  a  person  keeps 
track  of  his  own  receipts  and  disbursements  of  cash,  he  is 
not  keeping  the  account  to  show  how  much  cash  he  has  on 
hand;  he  is  keeping  the  account  for  the  purpose  of  showing 
how  much  cash  he  would  have  on  hand  if  there  were  no  loss 
nor  gain.  Now,  what  is  true  of  cash  account  is  true  of  all 
the  other  accounts;  they  are  all  kept  for  exactly  the  same 
purpose.  Every  account  in  the  ledger,  whether  it  be  a  per- 
sonal account  or  an  account  like  Cash  or  Merchandise  or 
an  account  like  Interest  or  Expense,  or  whether  it  be  the 
proprietor's  account,  is  kept  for  the  purpose  of  showing  what 
the  asset  or  liability  (or  net  asset  or  net  liability)  would  be 
if  there  were  no  loss  nor  gain.  In  every  case,  what  the  asset 
or  liability  (or  net  asset  or  net  liability)  is,  is  determined  in 
exactly  the  same  way  as  in  cash  account,  by  inventory.  In 
every  case,  if  the  amount  determined  by  inventory  agrees 
with  the  balance  of  the  account,  there  is  no  loss  nor  gain;  but 
if  the  two  amounts  differ,  the  difference  represents  the  loss 
or  gain  (or  net  loss  or  net  gain). 

In  the  above  statement  the  word  difference  is  used  in  the 


100  PRINCIPLES    OF 

algebraical  sense.  Assuming  that  an  account  shows  that, 
if  there  were  no  loss  nor  gain,  there  would  be  an  asset  of 
$100,  then,  if  the  inventory  shows  that  there  is  an  asset 
of  $150,  the  difference  (the  gain)  is  $50;  if  the  inventory 
shows  that  there  is  an  asset  of  $100,  the  difference  (the  loss 
or  gain)  is  zero;  if  the  inventory  shows  that  there  is  an 
asset  of  $40,  the  difference  (the  loss)  is  $60;  if  the  inventory 
shows  that  there  is  no  asset  nor  liability,  the  difference  (the 
loss)  is  $100;  if  the  inventory  shows  that  there  is  a  liability 
of  $80,  the  difference  (the  loss)  is  $180. 

Assuming  that  an  account  shows  that  if  there  were  no 
loss  nor  gain  there  would  be  a  liability  of  $100,  then,  if  the 
inventory  shows  that  there  is  a  liability  of  $150,  the  difference 
(the  loss)  is  $50;  if  the  inventory  shows  that  there  is  a 
liability  of  $100,  the  difference  (the  loss  or  gain)  is  zero; 
if  the  inventory  shows  that  there  is  a  liability  of  $40,  the 
difference  (the  gain)  is  $60;  if  the  inventory  shows  that  there 
is  no  asset  nor  liability,  the  difference  (the  gain)  is  $100; 
if  the  inventory  shows  that  there  is  an  asset  of  $80,  the  differ- 
ence (the  gain)  is  $180. 

The  above  line  of  reasoning  applies  to  every  account  of 
original  entry.  In  other  words,  it  applies  to  all  personal 
accounts,  to  Bills  Receivable  and  Bills  Payable,  to  all  property 
accounts,  like  Cash,  Merchandise  and  Real  Estate,  and  to  all 
accounts  representing  causes  of  outgo  and  income,  like  Inter- 
est and  Expense.  The  same  line  of  reasoning  also  applies  to 
the  accounts  of  duplicate  entry  (net  capital  account  and 
its  subdivisions),  but  in  this  case  the  wording  would  differ 
somewhat,  since  in  place  of  the  terms  asset,  liability,  loss  and 
gain,  we  would  use  the  terms  net  asset,  net  liability,  net  loss 
and  net  gain. 

Assuming,  for  example,  that  at  the  end  of  the  period  the 
proprietor's  account  (or  the  aggregate  of  its  subdivisions) 
shows  a  net  credit  of  $30,000,  it  means  that  if  there  were  no 
loss  nor  gain  there  would  be  a  net  asset  of  $30,000.  If,  now, 


DOUBLE-ENTRY    BOOKKEEPING  101 

the  inventory  shows  that  there  is  a  net  asset  of  $35,000,  the 
difference  (the  net  gain)  is  $5,000;  if  the  inventory  shows 
that  there  is  a  net  asset  of  $27,000,  the  difference  (the  net 
loss)  is  $3,000. 

The  bookkeeper,  then,  should  note  this  fact :  If  he  wishes 
to  understand  double-entry  bookkeeping,  he  must  get  rid  of 
the  idea  that  all  accounts  are  divided  into  asset-and-liability 
accounts  and  loss-and-gain  accounts,  and  that  in  the  one 
class  of  accounts  as  compared  with  the  other  the  rule  for 
debiting  and  crediting  is  reversed.  There  is  no  such  division 
and  there  is  no  such  reversal.  When  we  receive  from  Interest 
we  credit  Interest,  when  we  give  to  Cash  we  debit  Cash ;  when 
we  receive  from  Cash  we  credit  Cash,  when  we  give  to  Expense 
we  debit  Expense.  We  always  credit  the  person  from  whom 
*we  receive  and  debit  the  person  to  whom  we  give;  there  is 
no  exception  to  that  rule.  The  rule  applies  to  accounts  like 
Cash  and  Merchandise  exactly  as  it  applies  to  accounts  like 
Interest  and  Expense. 

In  double-entry  bookkeeping  all  accounts  are  divided  into   ^ 
two  classes,  but  the  line  of  division  is  not  between  accounts      ) 
which  deal  with  assets  and  liabilities  and  accounts  which  deal 
with  losses  and  gains;  the  line  of  division  is  between  accounts 
which  deal  with  assets  and  liabilities  and  losses  and  gains  and 
accounts  which  deal  with  net  asset  and  net  liability  and  net 
Uoss-and_netgain.j  The  former  are__the  accounts  of  original^ 
entry^  the  latterare  the  accounts  of^dupHc^^^trjr^/the 
former  are  between  the  proprietor  and  the  outside  parties 
severally,  the  latter  are  between  the  proprietor  and  the  outside 
parties  collectively.     In  every  account  of  original  entry  one 
of  the  outside  parties  is  the  first  party  and  the  proprietor  is 
the  second  party;  in  every  account  of  duplicate  entry  the      ! 
proprietor  is  the  first  party  and  the  outside  parties  collec-      i 
tively  are  the  second  party. 


102  PRINCIPLES    OF 

CHAPTER    XII 

SELF-CONTRADICTORY   DEBTS. 

Bookkeeping  is  in  its  simplest  form  when  the  accounts 
cover  all  the  financial  affairs  of  the  person  or  persons  for 
whom  the  books  are  kept;  but  that  is  not  often  the  case. 
It  is  never  the  case  when  the  books  are  those  of  a  firm  or  a 
company,  and  it  is  rarely  the  case  when  the  owner  is  an 
individual.  A  person  can,  of  course,  keep  one  set  of  books 
to  cover  all  of  his  own  affairs,  but  there  are  not  many  who 
do  it.  A  man  is  not  apt  to  keep  formal  accounts  at  all, 
unless  he  is  engaged  in  business  of  some  kind;  and  in  that 
case,  even  when  he  is  his  own  bookkeeper,  he  usually  keeps 
his  business  affairs  separate  from  his  personal  affairs.  More- 
over, as  a  rule  the  bookkeeper  is  not  the  owner  himself,  but 
an  employee,  and  his  duties  are  confined  to  a  certain  business ; 
he  has  nothing  to  do  with  any  of  his  employer's  affairs  outside 
of  that  business.  He  must,  therefore,  distinguish  between 
those  affairs  of  the  owner  which  pertain  to  the  business 
whose  accounts  he  is  keeping,  and  those  which  do  not.  In 
other  words,  he  must  regard  the  owner  in  two  distinct  lights, 
as  if  he  were  a  combination  of  two  persons,  one  the  pro- 
prietor of  the  business  and  the  other  an  outside  party. 

This  distinction  is  necessary  in  bookkeeping,  but  the  law 
recognizes  it  only  to  a  limited  extent.  In  the  case  of  an 
individual  owner  we  distinguish,  for  the  purposes  of  book- 
keeping, between  the  owner  as  an  outside  party  and  the 
owner  as  proprietor,  and  may  record  debts  between  the  two 
parties.  But  the  law  does  not  recognize  the  distinction  and 
therefore  does  not  recognize  the  debts. 

In  the  case  of  a  firm  we  distinguish,  for  the  purposes  of 
bookkeeping,  between  the  partners  as  proprietors  and  the 
partners  as  outside  parties,  but  the  law  recognizes  the  dis- 


DOUBLE-ENTRY   BOOKKEEPING 


103 


tinction  only  to  this  extent:  A  partner  is  not  responsible 
for  the  personal  debts  of  the  other  partners,  but  he  is  respon- 
sible for  all  the  debts  of  the  firm.  Therefore  the  law  does 
not  recognize  debts  between  a  firm  and  its  members. 

If  Smith,  Jones  and  Brown,  for  example,  are  equal 
partners,  and  Smith  lends  $3,000  to  the  firm,  then,  for  the 
purposes  of  bookkeeping,  we  say  that  the  firm  owes  Smith 
$3,000,  and  record  the  debt  in  the  ledger.  But  the  law  does 
not  recognize  the  debt.  The  legal  view  of  the  matter  is  that 
Jones  owes  Smith  $1,000  and  Brown  owes  Smith  $1,000; 
the  debt  of  $1,000  which  Smith  as  proprietor  owes  to  Smith 
as  an  outside  party  is  not  recognized  at  all.  In  other  words, 
when  Smith  lends  money  to  the  firm,  the  law  does  not 
recognize  the  debt  as  a  debt  of  the  firm;  it  regards  it  simply 
sis  a  personal  matter  between  Smith,  Jones  and  Brown.  But 
for  the  purposes  of  bookkeeping  we  regard  it  as  a  debt  of 
the  firm.  The  advantage  of  doing  so  is  that  it  enables  us  to 
record  the  whole  operation  by  means  of  these  entries: 


JOURNAL 


Cash,  to  Firm    

John   Smith,   to  Firm 


Dr. 
$3,000 


$3,000 


LEDGER 


Dr. 

Cash                   Cr. 
To  Firm 

Dr.            John  Smith 
To  Firm 

Cr. 

$3,000 

$3,000 

If  we  took  the  legal  view  of  the  matter,  we  would  have 
to  assume  that  Smith  lends  $1,000  to  Jones  and  $1,000  to 
Brown,  and  then  each  of  the  three  partners  contributes 
$1,000.  We  could  record  the  contributions,  but  the  debts 
which  Jones  and  Brown  owe  to  Smith  could  not  be  recorded 


104  PRINCIPLES    OF 

in  the  books  at  all,  since  the  books  deal  only  with  the  affairs 
of  the  firm. 

In  the  case  of  a  corporation  in  which  the  liability  of  the 
stockholders  is  limited,  the  legal  distinction  between  the  stock- 
holders as  proprietors  and  the  stockholders  as  outside  parties 
closely  resembles  the  distinction  which  is  made  in  bookkeep- 
ing. The  debts  of  a  corporation  are  not  personal  liabilities 
of  the  stockholders,  but  they  are  liabilities  of  the  stockholders 
as  proprietors. 

But  although  it  is  necessary  to  distinguish  clearly  between 
the  owner  as  an  outside  party  and  the  owner  as  proprietor, 
and  although  for  the  purposes  of  bookkeeping  we  may  record 
debts  between  the  two  parties,  yet,  from  the  very  nature  of 
things,  a  debt  is  self-contradictory  to  the  extent  to  which 
the  same  person  is  on  both  sides  of  it.  Therefore,  a  state- 
ment which  is  made  for  the  information  of  the  public  should 
not  include  such  debts,  unless  they  are  specifically  recognized 
by  the  law. 

When  a  dividend  is  recorded  in  the  books  of  a  company 
as  declared,  the  item  represents  a  self -contradictory  debt, 
a  debt  owed  by  the  stockholders  as  proprietors  to  the  stock- 
holders as  outside  parties.  Each  stockholder  is  on  both  sides 
of  the  debt  to  exactly  the  same  extent;  as  proprietor  he  is 
debtor  to  the  same  extent  to  which,  as  an  outside  party,  he 
is  creditor.  But  in  the  public  statement  of  a  corporation  it 
is  proper  to  show  such  an  item  as  a  liability,  because,  if  the 
dividend  was  declared  in  accordance  with  the  law,  the  law 
recognizes  the  debt. 

Individual  proprietors  and  firms  are  not  apt  to  make 
public  statements  at  all.  The  only  statements  which  they 
make  to  outside  parties  are  for  the  purpose  of  showing  their 
financial  responsibility,  and  in  such  statements  property  which 
they  own  outside  of  the  business  counts  the  same  as  capital 
invested  in  the  business.  In  the  case  of  individual  pro- 
prietors and  of  firms,  the  bookkeeper's  statement  of  assets, 


DOUBLE-ENTRY    BOOKKEEPING  105 

liabilities  and  net  capital  is  made  solely  for  the  information 
of  the  proprietors,  and  therefore  it  may  contain  self -con- 
tradictory debts  without  danger  of  deceiving  anybody,  since 
the  proprietors  know  exactly  what  they  mean. 

In  double-entry  bookkeeping,  then,  there  are  four  classes 
of  debts  in  which  the  proprietor  is  or  may  be  concerned. 

1.  Debts  between   the  proprietor  and  real   persons  or 
organizations  of  real  persons. 

Such  debts  are  recognized  by  the  law.  When  owed  to 
the  proprietor,  they  represent  asset  if  good  and  loss  if  bad. 
When  owed  by  the  proprietor,  they  must  be  considered  good 
as  long  as  the  business  continues,  and  therefore  they  repre- 
sent liability. 

2.  Debts  between  the  proprietor  and  imaginary  persons 
like  Cash,  Merchandise,  Interest  and  Expense. 

Such  relations  are  debts  only  for  the  purposes  of  book- 
keeping, but  they  represent  real  assets  and  liabilities  if  good, 
and  real  losses  and  gains  if  bad. 

3.  Debts  between  the  proprietor  and  the  outside  parties 
collectively. 

Such  relations  are  debts  only  for  the  purposes  of  book- 
keeping, but  they  represent  net  asset  or  net  liability  if  good, 
and  net  loss  or  net  gain  if  bad. 

4.  Debts  which  involve  the  question  of  a  man's  personal 
interest  as  distinguished  from  his  proprietorship  interest. 

In  general,  such  relations  are  debts  only  for  the  purposes 
of  bookkeeping,  but  in  some  cases  and  to  a  certain  extent  they 
are  recognized  by  the  law.  Debts  of  the  fourth  class  are 
either  wholly  or  partially  self-contradictory.  To  the  extent 
to  which  they  are  self -contradictory  and  good,  they  represent 
self-contradictory  assets  and  liabilities;  to  the  extent  to 
which  they  are  self -contradictory  and  bad,  they  represent 
withdrawals  and  contributions,  since  a  withdrawal  is  a 'self- 
contradictory  loss  and  a  contribution  is  a  self -contradictory 
gain. 


106  PRINCIPLES    OF 

If  the  owner  of  the  business  draws  out  a  certain  amount 
of  money  with  the  intention  of  replacing  it,  he  instructs  the 
bookkeeper  to  charge  it  to  his  personal  account,  and  the 
bookkeeper  regards  the  item  as  an  asset,  although  of  course 
he  knows  that  it  is  a  self -contradictory  asset.  If,  later,  the 
owner  decides  not  to  replace  the  money,  the  debt  becomes 
bad;  but  it  does  not  represent  a  loss,  it  represents  a  with- 
drawal. 

If  the  owner  puts  a  certain  amount  of  money  into  the 
business  temporarily,  he  instructs  the  bookkeeper  to  credit 
his  personal  account  with  it,  and  the  bookkeeper  regards  the 
item  as  a  liability,  although  of  course  he  knows  that  it  is  a 
self -contradictory  liability.  If,  later,  the  owner  decides  to 
leave  the  money  in  the  business,  the  debt  becomes  bad ;  but  it 
does  not  represent  a  gain,  it  represents  a  contribution. 

If  the  stockholders  of  a  company  decide  to  distribute  a 
dividend  and  enter  it  in  the  books  as  declared,  the  item 
represents  a  liability  and  they  have  made  a  withdrawal.  If, 
later,  they  decide  to  rescind  that  action,  the  debt  becomes  bad  ; 
but  it  does  not  represent  a  gain,  it  represents  a  contribution 
which  offsets  the  previous  withdrawal. 

If  the  stockholders  decide  to  make  an  assessment  and  enter 
it  in  the  books  as  levied,  the  item  represents  an  asset  and  they 
have  made  a  contribution.  If,  now,  some  of  the  stockholders 
fail  to  pay  the  assessment  the  debt  becomes  bad  to  that  extent ; 
but  it  does  not  represent  a  loss,  it  represents  an  unauthorized 
withdrawal  of  a  part  of  the  previous  contribution. 

If  three  men  are  equal  partners  and  one  of  them  borrows 
money  from  the  firm,  the  debt,  if  bad,  does  not  represent  loss 
from  the  standpoint  of  the  firm.  From  the  standpoint  of 
each  of  the  other  two  partners,  it  represents  loss  to  the  extent 
of  one- third  of  the  amount;  but  from  the  standpoint  of  the 
firm  it  represents  an  unauthorized  withdrawal.  If  such  a 
debt  becomes  bad  it  disrupts  the  firm,  and  if  a  stockholder's 


DOUBLE-ENTKY    BOOKKEEPING  107 

debt  to  a  company  on  account  of  an  assessment  becomes  bad, 
it  disrupts  his  relations  with  the  company. 

•Since  it  is  understood  that  self -contradictory  debts  which 
are  bad  represent  withdrawals  or  contributions  and  not  losses 
or  gains,  and  since  such  debts  are  of  comparatively  rare 
occurrence  in  bookkeeping,  it  will  simplify  the  matter  to 
dismiss  them  from  further  consideration,  and  to  discuss  the 
theory  on  the  assumption  that  there  are  no  such  debts.  In 
that  way  we  will  avoid  the  necessity  of  explaining  in  each 
particular  case,  that  certain  general  statements  do  not  apply 
to  self -contradictory  debts. 


108  PRINCIPLES    OF 

CHAPTER    XIII 

THE  COMPLETE  THEORY  OF  DOUBLE-ENTRY  BOOKKEEPING. 

The  principles  upon  which  double-entry  bookkeeping  is 
based  have  been  explained  in  the  preceding  chapters  and 
therefore  all  that  remains  now  is  to  condense  the  discussion 
and  present  the  theory  as  a  whole.  In  order  to  cover  all 
possible  cases  it  is  necessary  to  state  the  theory  twice,  once 
on  the  assumption  that  the  books  include  all  the  financial 
affairs  of  the  owner,  and  again  on  the  assumption  that  they 
do  not.  In  the  first  case  there  is,  of  course,  no  such  thing 
as  contributing  or  withdrawing  capital;  the  whole  operation 
of  bookkeeping  consists  in  opening  the  books,  recording 
transactions,  closing  the  books  and  re-opening  them.  But 
the  second  case  involves  the  necessity  of  making  a  distinction 
between  the  owner  as  proprietor  of  the  business  whose 
accounts  we  are  keeping  and  the  owner  as  an  outside  party; 
and  in  this  case  we  have  to  deal  with  contributions  and  with- 
drawals as  well  as  with  transactions. 

Case  I.  The  books  cover  all  the  financial  affairs  of  the 
owner. 

Opening  the  books : 

To  open  the  books  we  take  an  inventory  of  the  owner's 
assets  and  liabilities.  His  liabilities  are  always  in  the  form 
of  debts,  while  some  of  his  assets  may  be  in  the  form  of 
debts  and  others  may  be  in  material  form;  but  if  he  has  any 
assets  in  material  form,  he  is  supposed  to  lend  them  to 
certain  outside  parties  called  Cash,  Merchandise,  Real  Estate, 
etc.,  and  then  all  his  assets  as  well  as  his  liabilities  are  in 
the  form  of  debts.  This  conception  enables  us  to  record  all 
the  assets  as  debts  owed  to  the  owner  and  all  the  liabilities  as 
debts  owed  by  the  owner — and  to  record  them  in  duplicate, 
once  as  debts  between  the  owner  and  the  outside  parties 


DOUBLE-ENTRY    BOOKKEEPING  109 

severally,  and  again  as  debts  between  the  owner  and  the  out- 
side parties  collectively.  To  the  extent  to  which  the  debts 
between  the  owner  and  the  outside  parties  collectively  cancel 
each  other  the  entries  are,  of  course,  omitted. 

Recording  transactions: 

In  every  transaction  the  owner  is  supposed  to  borrow  some- 
thing from  one  person  and  to  lend  it  to  another;  therefore  to 
record  a  transaction  we  credit  the  person  from  whom  he 
borrows  and  debit  the  person  to  whom  he  lends.  Theoretically, 
these  debts  are  also  recorded  in  duplicate,  but  since  the 
duplicate  entries  always  cancel  each  other,  they  are  omitted. 

Closing  and  re-opening  the  books : 

To  close  and  re-open  the  books  we  take  another  inventory 
of  the  assets  and  liabilities.  In  the  case  of  each  asset  the 
owner  is  supposed  to  borrow  the  amount  on  old  account  from 
the  person  whose  name  indicates  the  form  of  the  asset,  and 
to  lend  it  to  him  on  new  account.  In  the  case  of  each  lia- 
bility the  owner  is  supposed  to  lend  the  amount  on  old 
account  to  the  person  whose  name  indicates  the  form  of  the 
liability,  and  to  borrow  it  from  him  on  new  account.  These 
debts  are  also  recorded  in  duplicate,  except  to  the  extent  to 
which  the  duplicate  entries  cancel  each  other. 

In  the  old  accounts,  now,  the  debit  entries  in  each  account 
of  original  entry  show  the  amounts  whkh  the  owner  has  given 
to  the  party  whose  name  heads  the  account,  and  the  credit 
entries  show  the  amounts  which  the  owner  has  received  from 
him.  The  difference,  therefore,  represents  the  loss  or  gain 
under  that  heading,  an  excess  debit  representing  a  loss  and 
an  excess  credit  representing  a  gain.  In  the  account  of  dupli- 
cate entry  the  debit  entries  show  the  amounts  which  the 
owner  has  received  from  the  outside  parties  collectively,  and 
the  credit  entries  show  the  amounts  which  the  owner  has  given 
to  them.  The  difference,  therefore,  represents  the  net  gain 
or  net  loss,  an  excess  debit  representing  the  net  gain  and  an 
excess  credit  representing  the  net  loss. 


110  PRINCIPLES    OF 

To  record  the  losses  and  gains  and  the  net  loss  or  net  gain, 
we  balance  all  of  the  accounts. 

Case  II.  The  books  cover  only  a  portion  of  the  financial 
affairs  of  the  owner  or  owners. 

This  is  always  the  case  when  there  is  more  than  one  owner, 
and  is  usually  the  case  when  the  owner  is  an  individual. 
This  case  involves  the  idea  of  contributing  and  withdrawing 
capital,  and  therefore  it  is  necessary  to  distinguish  clearly 
between  the  act  of  contributing  capital  and  the  act  of  lending 
it,  and  between  the  act  of  withdrawing  capital  and  the  act 
of  borrowing  it.  When  a  man  contributes  money  to  a  firm 
or  a  company,  he  acquires  an  interest  in  the  business,  when 
he  lends  money  to  it  he  does  not;  the  two  operations  are 
entirely  distinct. 

If  Smith  lends  $1,000  to  a  certain  company  and  Jones 
buys  $1,000  worth  of  stock  in  the  same  company,  it  is  very 
evident  that  the  company  owes  Smith  $1,000,  and  it  is  equally 
evident  that  the  company  does  not  owe  Jones  anything.  In 
the  one  case,  Smith  has  given  the  money  to  the  company  and 
has  received  nothing  in  return,  therefore  the  company  owes 
him  $1,000 ;  in  the  other  case,  Jones  has  exchanged  individual 
ownership  for  corporate  ownership,  therefore  there  is  no 
debt.  When  a  member  of  a  firm  contributes  money  to  the 
business,  he  exchanges  individual  ownership  for  joint  owner- 
ship ;  when  an  individual  proprietor  contributes  money  to  the 
business,  he  exchanges  personal  ownership  for  business 
ownership,  therefore  there  is  no  debt.  Contributions  and 
withdrawals,  then,  do  not  give  rise  to  debt;  that  is  to  say, 
they  do  not  cause  the  recipient  to  owe  the  giver.  It  is  true 
that  when  an  assessment  is  recorded  in  the  books  of  a  com- 
pany as  levied  or  when  a  dividend  is  recorded  as  declared,  the 
item  represents  a  debt;  but  in  all  such  cases  the  debt  is  owed 
by  the  giver  to  the  recipient,  and  therefore  does  not  constitute 
an  exception  to  the  above  statement. 

Since  double-entry  bookkeeping  can  record  only  debts  we 


DOUBLE-ENTEY    BOOKKEEPING  111 

will,  in  stating  the  theory,  use  the  terms  borrow  and  lend 
in  connection  with  operations  which  give  rise  to  debt  and 
therefore  are  recorded,  and  will  use  the  term  transfer  in 
connection  with  operations  which  do  not  give  rise  to  debt 
and  therefore  are  not  recorded. 

In  outline  the  theory  is  as  follows: 

At  the  beginning  of  the  period  the  owner  contributes  the 
net  capital;  that  is  to  say,  the  owner  as  an  outside  party  trans- 
fers to  the  owner  as  proprietor  the  then  existing  assets  and 
liabilities. 

During  the  period  the  owner  may  contribute  additional 
capital  and  he  may  withdraw  portions  of  the  capital,  and  he 
engages  in  transactions. 

At  the  close  of  the  period  the  owner  withdraws  the  net 
capital;  that  is  to  say,  the  owner  as  proprietor  transfers  to 
the  owner  as  an  outside  party  the  then  existing  assets  and 
liabilities. 

The  difference,  now,  between  what  the  owner  has  con- 
tributed and  what  he  has  withdrawn  is  the  net  loss  or  net  gain. 

To  open  the  new  period  the  owner  again  contributes  the 
net  capital ;  that  is  to  say,  at  the  beginning  of  the  new  period 
the  owner  as  an  outside  party  transfers  to  the  owner  as  pro- 
prietor the  assets  and  liabilities  which  were  withdrawn  at  the 
end  of  the  preceding  period. 

The  operation  of  transferring  assets  and  liabilities  may  be 
illustrated  in  this  way: 

1.  The  owner  as  an  outside  party  has  an  asset,  a  debt 
owed  to  him  by  John  Smith,  and  this  asset  is  to  be  trans- 
ferred to  the  owner  as  proprietor. 

The  owner  as  an  outside  party  borrows  the  amount  from 
Smith  (thus  canceling  the  debt  owed  to  him  by  Smith)  and 
transfers  it  to  the  owner  as  proprietor,  who  in  turn  lends  it 
to  Smith.  The  operation,  then,  has  this  result:  At  first 
Smith  owed  the  owner  as  an  outside  party,  now  he  owes  the 


112  PRINCIPLES    OF 

owner  as  proprietor;  the  asset  has  been  transferred  from  the 
owner  as  an  outside  party  to  the  owner  as  proprietor. 

2.  The  owner  as  an  outside  party  has  a  liability,  a  debt 
owed  by  him  to  Wm.  Jones,  and  this  liability  is  to  be  trans- 
ferred to  the  owner  as  proprietor. 

The  owner  as  proprietor  borrows  the  amount  from  Jones 
and  transfers  it  to  the  owner  as  an  outside  party,  who  in 
turn  lends  it  to  Jones  (thus  canceling  the  debt  owed  by  him 
to  Jones).  The  operation,  then,  has  this  result:  At  first 
the  owner  as  an  outside  party  owed  Jones,  now  the  owner  as 
proprietor  owes  Jones;  the  liability  has  been  transferred  from 
the  owner  as  an  outside  party  to  the  owner  as  .proprietor. 

It  will  be  noted  that  when  the  owner  contributes  an  asset, 
the  amount  is  transferred  from  the  owner  as  an  outside  party 
to  the  owner  as  proprietor,  and  that  when  the  owner  con- 
tributes a  liability,  the  amount  is  transferred  from  the  owner 
as  proprietor  to  the  owner  as  an  outside  party.  It  follows, 
therefore,  that  when  the  owner  contributes  the  assets  and 
liabilities  which  compose  the  net  capital  at  the  beginning  of 
the  period,  he  contributes  the  amounts  of  the  assets  and  with- 
draws the  amounts  of  the  liabilities,  and  when  he  withdraws 
the  assets  and  liabilities  which  compose  the  net  capital  at 
the  end  of  the  period,  he  withdraws  the  amounts  of  the  assets 
and  contributes  the  amounts  of  the  liabilities. 

It  will  be  noted,  also,  that  a  system  of  accounting  which 
records  all  assets  and  liabilities  in  the  form  of  debts  is  neces- 
sarily based  upon  the  idea  that  the  owner  as  proprietor  never 
keeps  anything  in  his  possession;  whatever  he  receives  from 
one  person  he  immediately  lends  to  another,  or  else  he  trans- 
fers it  to  the  owner  as  an  outside  party.  Therefore,  all  his 
assets  as  well  as  his  liabilities  are  in  the  form  of  debts;  he 
never  has  any  assets  or  liabilities  in  any  other  form. 

The  complete  theory,  then,  is  as  follows : 

To  open  the  books: 

The  assets  and  liabilities  are  determined  by  inventory. 


DOUBLE-ENTRY   BOOKKEEPING  113 

The  owner  as  an  outside  party  transfers  to  the  owner  as 
proprietor  the  amounts  of  the  assets.  This  operation  does 
not  give  rise  to  debt  and  therefore  is  not  recorded.  The 
proprietor  lends  these  amounts  to  the  parties  whose  names 
indicate  the  form  of  the  assets.  To  record  these  debts  in 
duplicate  we  credit  the  proprietor  and  debit  the  parties  to 
whom  he  lends. 

The  proprietor  borrows  the  amounts  of  the  liabilities  from 
the  parties  whose  names  indicate  the  form  of  the  liabilities. 
To  record  these  debts  in  duplicate  we  debit  the  proprietor 
and  credit  the  parties  from  whom  he  borrows.  The  owner 
as  proprietor  transfers  these  amounts  to  the  owner  as  an 
outside  party.  This  operation  does  not  give  rise  to  debt  and 
therefore  is  not  recorded. 

To  the  extent  to  which  the  debits  and  credits  to  the  pro- 
prietor cancel  each  other,  they  are  omitted;  only  the  excess 
of  the  one  over  the  other  is  entered. 

To  record  a  contribution  : 

The  owner  as  an  outside  party  transfers  to  the  owner  as 
proprietor  the  amount  of  the  contribution.  This  operation 
does  not  give  rise  to  debt  and  therefore  is  not  recorded.  The 
proprietor  lends  this  amount  to  the  party  whose  name  indi- 
cates the  form  of  the  income.  To  record  this  debt  in  duplicate 
we  credit  the  proprietor  and  debit  the  party  to  whom  he 
lends. 

To  record  a  withdrawal: 

The  proprietor  borrows  the  amount  of  the  withdrawal 
from  the  party  whose  name  indicates  the  form  of  the  outgo. 
To  record  this  debt  in  duplicate  we  debit  the  proprietor  and 
credit  the  party  from  whom  he  borrows.  The  owner  as 
proprietor  transfers  this  amount  to  the  owner  as  an  outside 
party.  This  operation  does  not  give  rise  to  debt  and  there- 
fore is  not  recorded. 

To  record  a  transaction: 

The  proprietor  borrows  from  one  person  and  lends  to 


114  PRINCIPLES    OF 

another  the  amount  involved  in  the  transaction.  To  record 
the  first  debt  in  duplicate  we  debit  the  proprietor  and  credit 
the  party  from  whom  he  borrows.  To  record  the  second  debt 
in  duplicate  we  credit  the  proprietor  and  debit  the  party  to 
whom  he  lends.  Since,  the  debit  and  credit  to  the  proprietor 
cancel  each  other,  the  entries  are  omitted. 

To  close  the  books: 

The  assets  and  liabilities  are  again  determined  by 
inventory. 

The  proprietor  borrows  the  amounts  of  the  assets  from 
the  parties  whose  names  indicate  the  form  of  the  assets.  To 
record  these  debts  in  duplicate  we  debit  the  proprietor  and 
credit  the  parties  from  whom  he  borrows.  The  owner  as 
proprietor  transfers  these  amounts  to  the  owner  as  an  outside 
party.  This  operation  does  not  give  rise  to  debt  and  there- 
fore is  not  recorded. 

The  owner  as  an  outside  party  transfers  to  the  owner  as 
proprietor  the  amounts  of  the  liabilities.  This  operation 
does  not  give  rise  to  debt  and  therefore  is  not  recorded. 
The  proprietor  lends  these  amounts  to  the  parties  whose 
names  indicate  the  form  of  the  liabilities.  To  record  these 
debts  in  duplicate  we  credit  the  proprietor  and  debit  the 
parties  to  whom  he  lends. 

To  the  extent  to  which  the  debits  and  credits  to  the  pro- 
prietor cancel  each  other,  they  are  omitted;  only  the  excess 
of  the  one  over  the  other  is  entered. 

These  entries  complete  the  record  of  the  operations  of 
the  closing  period.  In  each  account  of  original  entry  the 
debits  now  show  the  amounts  which  the  proprietor  has  given 
to  the  party  whose  name  heads  the  account,  and  the  credits 
show  the  amounts  which  the  proprietor  has  received  from 
him;  therefore  an  excess  debit  represents  loss  and  an  excess 
credit  represents  gain.  In  the  account  of  duplicate  entry 
the  debits  show  the  amounts  which  the  proprietor  has  received 
from  the  outside  parties  collectively,  and  the  credits  show  the 


DOUBLE-ENTRY   BOOKKEEPING  115 

amounts  which  he  has  given  to  them ;  therefore  an  excess  debit 
represents  the  net  gain,  an  excess  credit  represents  the  net  loss. 

To  record  the  losses  and  gains  and  the  net  loss  or  net  gain 
we  balance  all  of  the  accounts,  the  amount  to  balance  an 
excess  debit  being  entered  on  the  credit  side  and  the  amount 
to  balance  an  excess  credit  being  entered  on  the  debit  side. 

To  re-open  the  books: 

The  owner  contributes  the  assets  and  liabilities  again  and 
the  work  proceeds  as  before. 

In  our  statement  of  the  theory  we  assume  that  the  owner 
is  an  individual ;  in  the  case  of  a  firm  or  a  company,  of  course, 
the  wording  would  be  somewhat  different.  In  the  case  of  a 
firm  we  would  say:  The  partners  as  outside  parties  transfer 
to  the  firm  the  amounts  of  the  assets.  The  firm  lends  these 
amounts  to  the  parties  whose  names  indicate  the  form  of 
the  assets.  To  record  these  debts  in  duplicate  we  credit  the 
firm  and  debit  the  other  parties.  In  the  case  of  a  company 
the  statement  would  be  in  this  form:  The  stockholders  as 
outside  parties  transfer  to  the  company  the  amounts  of  the 
assets.  The  company  lends  these  amounts  to  the  parties 
whose  names  indicate  the  form  of  the  assets.  To  record  these 
debts  in  duplicate  we  credit  the  company  and  debit  the  other 
parties. 

The  reader  will  observe  that  the  principle  is  the  same  in 
all  three  cases.  In  the  case  of  an  individual  owner,  the 
owner  as  an  outside  party  transfers  to  the  owner  as  proprietor 
the  amounts  of  the  assets.  In  the  case  of  a  firm,  the  partners 
as  outside  parties  transfer  to  the  partners  as  proprietors  the 
amounts  of  the  assets.  In  the  case  of  a, company,  the  stock- 
holders as  outside  parties  transfer  to  the  stockholders  as 
proprietors  the  amounts  of  the  assets. 

When  the  proprietor  is  a  firm  or  a  company,  the  book- 
keeper omits  net  capital  account  and  carries  partnership 
accounts  or  accounts  like  Capital  Stock  and  Surplus  in  its 


116  PRINCIPLES    OF 

place.  In  each  of  these  accounts,  as  shown  in  Chapter  VIII, 
the  firm  or  the  company  is  the  first  party-  It  is  to  be  under- 
stood, then,  that  in  the  case  of  a  firm  or  a  company,  when  we 
speak  of  debiting  or  crediting  the  proprietor,  we  mean  that 
we  debit  or  credit  one  or  more  of  the  accounts  in  which  the 
firm  or  the  company  is  the  first  party. 

According  to  the  theory  stated  above  (and  it  is  the  only 
possible  theory  of  double-entry  bookkeeping)  all  operations 
which  give  rise  to  debt  are  recorded  twice,  except  to  the  extent 
to  which  the  duplicate  entries  cancel  each  other;  operations 
which  do  not  give  rise  to  debt  are  not  recorded  at  all.  When 
the  owner  contributes  money  we  do  not  record  the  actual 
contribution  at  all,  because  it  does  not  give  rise  to  debt; 
but  we  pretend  that  the  proprietor  lends  the  money  to  a 
person  called  Cash,  and  we  record  the  imaginary  loan  as 
giving  rise  to  an  imaginary  debt.  In  the  same  way,  when  we 
sell  merchandise  for  cash,  we  do  not  record  the  actual  trans- 
action with  the  customer  at  all,  because  it  does  not  give  rise 
to  debt.  In  place  of  it  we  record  imaginary  transactions  with 
persons  called  Cash  and  Merchandise  as  giving  rise  to 
imaginary  debts. 


DOUBLE-ENTKY    BOOKKEEPING  117 

CHAPTEK    XIV 

EXAMPLE   ILLUSTRATING   THE   THEORY. 

As  an  example  to  illustrate  the  theory  given  in  the  pre- 
ceding chapter  we  will  take  the  case  of  a  merchant  dealing 
in  flour,  since  the  barrel  of  flour  is  a  convenient  unit  in 
accounting,  and  will  assume  that  according  to  inventory 
the  assets  consist  of  $3,000  in  cash  and  2,000  barrels  of  flour, 
which  at  cost  price  ($5  per  barrel)  are  worth  $10,000,  and 
the  liabilities  consist  of  notes  outstanding  to  the  amount 
of  $1,000. 

The  process  of  opening  the  books  is  as  .follows : 
The  owner  as  an  outside  party  transfers  to  the  owner  as 
proprietor  the  amount  of  the  assets  ($13,000).  This  opera- 
tion does  not  give  rise  to  debt  and  therefore  is  not  recorded. 
The  proprietor  lends  $3,000  to  an  outside  party  called  Cash 
and  $10,000  to  an  outside  party  called  Merchandise,  there- 
fore Cash  and  Merchandise  owe  the  proprietor.  To  record 
these  debts  in  duplicate  we  make  the  following  entries: 

Dr.  Cr. 

Gash,  to  Proprietor    $3,000 

Merchandise,  to   Proprietor    10,000 

Proprietor,  to  Outside  Parties   $13,000 

The  proprietor  borrows  $1,000  from  an  outside  party 
called  Bills  Payable,  therefore  Bills  Payable  is  owed  by  the 
proprietor.  To  record  this  debt  in  duplicate  we  make  these 
entries : 

Dr.  Cr. 

Bills  Payable,  to  Proprietor   $1,000 

Proprietor,  to  Outside  Parties $1,000 

The  owner  as  proprietor  transfers  to  the  owner  as  an 
outside  party  the  $1,000  which  he  borrowed  from  Bills  Pay- 


118  PRINCIPLES    OF 

able.    This  operation  does  not  give  rise  to  debt  and  therefore 
is  not  recorded. 

The  credit  to  the  proprietor  is  $13,000,  the  debit  is  $1,000, 
the  net  credit  is  $12,000;  therefore  the  entries  to  open  the 
books  take  this  form : 

Dr.  Cr. 

Cash,  to  Proprietor   $3,000 

Merchandise,  to  Proprietor   10,000 

Bills  Payable,  to  Proprietor   $1,000 

Proprietor,  to  Outside  Parties   12,000 

First  transaction: 

1,000  barrels  of  flour  are  sold  for  cash  at  $5.70  per  barrel. 

The  proprietor  borrows  $5,700  from  the  outside  party 
called  Merchandise  and  lends  it  to  the  outside  party  called 
Cash,  therefore  Cash  owes  the  proprietor  and  Merchandise  is 
owed  by  the  proprietor.  To  record  these  debts  in  duplicate 
we  make  the  following  entries : 

Dr.  Cr. 

Cash,  to  Proprietor    $5,700 

Proprietor,  to  Outside  Parties    $5,700 

Merchandise,  to  Proprietor    5,700 

Proprietor,  to  Outside  Parties   5,700 

Since  the  debit  and  credit  to  the  proprietor  cancel  each 
other  it  is  unnecessary  to  record  them,  and  therefore  the 
entries  take  this  form: 

Dr.  Cr. 

Qash,  to   Proprietor    $5,700 

Merchandise,  to  Proprietor   $5,700 


Second  transaction: 

The  sum  of  $300  is  paid  out  for  expenses. 

The  proprietor  borrows  $300  from  the  outside  party  called 
Cash  and  lends  it  to  an  outside  party  called  Expense,  there- 
fore Expense  owes  the  proprietor  and  Cash  is  owed  by  the 


DOUBLE-ENTRY  BOOKKEEPING  119 

proprietor.     To  record  these  debts  in  duplicate  we  make  the 
following  entries: 

Dr.  Cr. 

Expense,  to  Proprietor   $300 

Proprietor,  to  Outside  Parties    $300 

Cash,   to  Proprietor    300 

Proprietor,  to  Outside  Parties   300 

Since  the  debit  and  credit  to  the  proprietor  cancel  each 
other  it  is  unnecessary  to  record  them,  and  therefore  the 
entries  take  this  form : 

Dr.  Cr. 

Expense,  to  Proprietor   $300 

Cash,  to  Proprietor    $300 

Third  transaction: 

500  barrels  of  flour  are  sold  for  cash  at  $5.80  per  barrel. 

Since  this  transaction,  except  as  to  the  amount  involved, 
is  the  same  as  the  first  one,  it  is  unnecessary  to  repeat  the 
discussion.  The  entries  are  as  follows: 

Dr.  Cr. 

Cash,  to  Proprietor    $2,900 

Merchandise,  to  Proprietor   $2,900 


Fourth  transaction : 

A  note  for  $400  is  paid  by  the  proprietor. 

The  proprietor  borrows  $400  from  the  outside  party  called 
Cash  and  lends  it  to  the  outside  party  called  Bills  Payable, 
therefore  Bills  Payable  owes  the  proprietor  and  Cash  is  owed 
by  the  proprietor.  To  record  these  debts  in  duplicate  we 
make  these  entries : 

Dr.  Cr. 

Bills  Payable,  to  Proprietor   $400 

Proprietor,  to  Outside  Parties   $400 

Cash,  to  Proprietor    400 

Proprietor,  to  Outside  Parties   400 


120  PRINCIPLES    OF 

Since  the  debit  and  credit  to  the  proprietor  cancel  each 
other  they  are  omitted,  and  the  entries  take  this  form: 

Dr.  Cr. 

Bills  Payable,  to  Proprietor   $400 

Oash,  to  Proprietor   $400 

Withdrawal : 

The  owner  draws  out  $200  for  personal  use. 

The  proprietor  borrows  $200  from  the  outside  party  called 
Cash,  therefore  Cash  is  owed  by  the  proprietor.  To  record 
this  debt  in  duplicate  we  make  these  entries: 

Dr.  Cr. 

Cash,   to  Proprietor   $200 

Proprietor,  to  Outside  Parties   $200 

The  owner  as  proprietor  transfers  the  $200  to  the  owner 
as  an  outside  party.  This  operation  does  not  give  rise  to  debt 
and  therefore  is  not  recorded. 

To  close  the  books  we  take  another  inventory  of  the  assets 
and  liabilities.  To  determine  the  asset  in  the  form  of  cash 
we  count  the  cash,  and  find  that  it  amounts  to  $10,700.  To 
determine  the  asset  in  the  form  of  merchandise  we  count  the 
barrels  of  flour  remaining,  and  find  that  there  are  500  (there 
were  2,000  barrels  on  hand  at  the  beginning  and  1,500  barrels 
have  been  sold).  The  500  barrels  of  flour  at  cost  price  ($5 
per  barrel)  are  worth  $2,500.  The  liability  remaining  in 
the  form  of  bills  payable  is  evidently  $600,  since  there  were 
notes  outstanding  to  the  amount  of  $1,000  at  the  beginning 
and  one  of  them  for  $400  has  been  paid. 

The  process  of  closing  the  books  is  as  follows : 

The  proprietor  borrows  $10,700  from  the  outside  party 
called  Cash  and  $2,500  from  the  outside  party  called  Mer- 
chandise, therefore  t  Cash  and  Merchandise  are  owed  by  the 
proprietor.  To  record  these  debts  in  duplicate  we  make  the 
following  entries: 


DOUBLE-ENTRY   BOOKKEEPING  121 


Dr.  Or. 

Cash,  to  Proprietor    $10,700 

Merchandise,  to  Proprietor   2,500 

Proprietor,  to  Outside  Parties   $13,200 


The  owner  as  proprietor  transfers  to  the  owner  as  an 
outside  party  the  $13,200  which  he  borrowed  from  Cash  and 
Merchandise.  This  operation  does  not  give  rise  to  debt  and 
therefore  is  not  recorded. 

The  owner  as  an  outside  party  transfers  to  the  owner  as 
proprietor  the  amount  of  the  liabilities  ($600).  This  opera- 
tion does  not  give  rise  to  debt  and  therefore  is  not  recorded. 
The  proprietor  lends  the  $600  to  the  outside  party  called 
Bills  Payable,  therefore  Bills  Payable  owes  the  proprietor. 

To  record  this  debt  in  duplicate  we  make  these  entries : 

Dr.  Cr. 

Bills  Payable,  to  Proprietor   $600 

Proprietor,  to  Outside  Parties   $600 


The  debit  to  the  proprietor  is  $13,200,  the  credit  is 
the  net  debit  is  $12,600;  therefore  the  entries  to  close  the 
books  take  this  form: 

Dr.  Cr. 

Proprietor,  to  Outside  Parties   $12,600 

Bills  Payable,  to  Proprietor  600 

Cash,  to  Proprietor  $10,700 

Merchandise,  to  Proprietor   2,500 


After  all  of  the  above  entries  have  been  transferred  to  the 
ledger,  then,  in  every  account  of  original  entry  an  excess 
debit  represents  loss  and  an  excess  credit  represents  gain; 
in  the  account  of  duplicate  entry  an  excess  debit  represents 
the  net  gain,  an  excess  credit  represents  the  net  loss.  To  record 
the  losses  and  gains  and  the  net  loss  or  net  gain  we  balance 
all  of  the  accounts. 


122 


PEINCIPLES  OF 


To  re-open  the  books: 

The  books  are  re-opened  in  exactly  the  same  way  in  which 
they  were  opened  in  the  first  place,  and  therefore  it  is  unneces- 
sary to  repeat  the  discussion.  It  is  evident  that  the  entries 
to  re-open  the  books  are  just  the  reverse  of  the  entries  to  close 
them,  since  the  owner  withdraws  the  net  capital  at  the  end 
of  the  closing  period  and  then  contributes  it  again  to  open 
the  new  period.  The  entries,  then,  to  re-open  the  books  are 
as  follows: 

Dr.  Cr. 

Cash,  to  Proprietor   $10,700 

Merchandise,  to  Proprietor   2,500 

Bills  Payable,  to  Proprietor  $600 

Proprietor,  to  Outside  Parties  12,600 

In  order  to  present  the  example  in  compact  form,  we  make 
the  following  recapitulation: 
Inventory  at  beginning: 


ASSETS 

LIABILITIES 

Cash    

.  .  $3,000 

Bills  Payable    

.  .  $1,000 

Merchandise    

.  .  10,000 

Total    

.  .  $1,000 

Bal.   (Net  Capital)    .  . 

..   12,000 

Total      

$13  000 

$13,000 

First  transaction. — 1,000  barrels  of  flour  are  sold  for  cash 
at  $5.70  per  ban-el. 

Second  transaction. — The  sum  of  $300  is  paid  out  for 
expenses. 

Third  transaction. — 500  barrels  of  flour  are  sold  for  cash 
at  $5.80  per  barrel. 

Fourth  transaction. — A  note  for  $400  is  paid  by  the  pro- 
prietor. 

Withdrawal. — The  owner  draws  out  $200  for  personal  use. 


DOUBLE-ENTRY    BOOKKEEPING 

Inventory  at  close: 


123 


ASSETS                                             LIABILITIES 

Cash    *1  n  ?nn      Bills  Pav 

able    . 

$600 

$600 
12,600 

Merchandise    . 

.     2,500 

Total 
Bal.   (Net 

Capital)    

Total    $13,200 

$13,200 

JOURNAL 
Dr.              Cr. 

To   open 
the  books 

1st   Trans- 
action 

2nd   Trans- 
action 

3rd    Trans- 
action 

4th    Trans- 
action 

Withdrawal 

To  close 
the  books 
(Dec.    31) 

To    re-open 
the  books 
(Jan.    1) 

Cash,  to  Proprietor 

(1) 
(2) 
(3) 

(4) 

(5) 
(6) 

(7) 
(8) 

(9) 
(10) 

(11) 
(12) 

(13) 
(14) 

(15) 

(16) 
(17) 
(18) 

(19) 
(20) 

(21) 
,(22) 

$3,000 
10,000 

5,700 
300 
2,900 

400 
200 

12,600 
600 

$10,700 
2,500 

$1,000 
12,000 

5,700 
300 
2,900 

400 
200 

10,700 
2,500 

$600 
12,600 

Merchandise,  to  Proprietor. 
Bills  Payable,  to  Proprietor 
Proprietor,     to     Outside 
Parties    

Cash,  to  Proprietor  

Merchandise,   to   Proprietor 

Expense,  to   Proprietor    .  .  . 
Cash,  to  Proprietor 

Cash,  to  Proprietor  

Merchandise,   to   Proprietor 

Bills    Payable    to    P  r  o  - 
prietor 

Cash,   to   Proprietor    

Proprietor,     to     Outside 
Parties    

Cash,  to  Proprietor  

Proprietor,     to     Outside 
Parties 

Bills    Payable    to    P  r  o  • 
prietor 

Cash    to   Proprietor 

Merchandise,  to   Proprietor 

Cash    to  Proprietor  

Merchandise,   to   Proprietor 
Bills    Payable    to    Pro- 
prietor     

Proprietor,     to     Outside 
Parties    

124 


PRINCIPLES    OF 


Dr. 

LED 
Ca 

am 
sh                                               Cr. 
To  Proprietor 

Inventory 

(1)     $3,000 
(5)       5,700 
(9)       2,900 

(8)        $300 
(12)          400 
(14)          200 
Bal.    (Invty.)            (17)     10,700 

Total  Debits   . 

$11,600 

Total    Prpdits                   $11  fiOfl 

Bal.   (Invty.) 

(19)  $10,700 

Dr. 


Merchandise 

To  Proprietor 


Cr. 


Inventory 


(2)     $10,000 


Total  Debits   $10,000 

Excess  Credit  (Gain)   ..     1,100 

$11,100 
Bal.   (Invty.)          (20)       $2,500 


(6)       $5,700 

(10)         2,900 

Bal.  (Invty.)          (18)         2,500 


Total  Credits    $11,100 


Dr. 


Bills  Payable 

To  Proprietor 


Cr. 


Bal.  (Invty.) 

(11)     $400 
(16)       600 

Inventory 

(3)     $1,000 

Total  Debits  .  . 

$1,000 

Total   Credits    . 

$1,000 

Bal.  (Invty.) 

(21)      $600 

Dr. 


Expense 

To  Proprietor 


Cr. 


(7)  $300 

Excess  Debit  (Loss) 

$300 

Total  Debits  .  . 

$300 

$300 

Dr. 


Proprietor 

To  Outside  Parties 


Cr. 


Bal.    (Invty.) 


(13)      $200 
(15)    12,600 


Total  Debits $12,800 


Inventory 


(4)   $12,000 


Total  Credits    $12,000 

Exc.  Debit  (Net  Gain)          800 

$12,800 


Bal.  (Invty.) 


(22)  $12,600 


DOUBLE-ENTKY   BOOKKEEPING 


125 


The  reader  will  observe  that  the  items  representing  losses 
and  gains  and  the  net  loss  or  net  gain  do  not  appear  in  the 
journal.  Such  an  item  is  not  a  part  of  the  account,  it  is  the 
result  of  the  account;  it  is  the  excess  of  the  one  side  over  the 
other  after  the  account  has  been  completed.  It  is  evident, 
however,  that  when  we  enter  these  amounts  in  the  ledger,  the 
total  entered  on  the  one  side  always  equals  the  total  entered 
on  the  other  side.  In  any  one  account  the  total  of  the  debits 
may  or  may  not  equal  the  total  of  the  credits;  but  in  the 
ledger  taken  as  a  whole  the  total  of  the  debits  always  equals 
the  total  of  the  credits,  and  therefore  in  the  various  accounts 
the  total  of  the  excess  debits  must  equal  the  total  of  the 
excess  credits. 

From  the  ledger  accounts  we  derive  the  following  state- 
ment showing  the  results  of  the  first  period : 


Cash                 

$10,700 

Bills  Payable   

$600 

Merchandise 

2  500 

Total     Liabilities    at 
Close        

$600 

Bal.     (Net    Capital    at 
Close)    .  . 

12  600 

Total  Assets  at  Close 

$13,200 

$13,200 

Bal.     (Net    Capital    at 
Close)        

$12,600 

Net   Capital   at   Begin- 
ning   

$12,000 

Withdrawals    

200 

Contributions   (None) 

Bal.  (Net  Gain)   

800 

$12,800 

$12,800 

Bal.    (Net  Gain)    . 
Expense   (Loss)    ..$300 
Total  Losses    .  .  . 

$800 
300 

Merchandise  (Gain)   .  . 

$1,100 

$1,100 

Total  Gains  

$1  100 

It  will  be  noted  that  the  middle  section  of  this  statement 
is  simply  a  copy  of  the  proprietor's  account.  The  purpose 
of  that  account  is  to  record  the  net  capital  at  the  beginning 


126  PKINCIPLES    OF 

and  any  subsequent  contributions  or  withdrawals.  The  aggre- 
gate of  these  entries  represents  the  contributed  capital  at 
the  close,  and  the  difference  between  that  amount  and  the 
net  capital  at  the  close  is  the  net  loss  or  net  gain.  This  must 
agree  with  the  aggregate  of  the  losses  and  gains  as  shown  in 
the  third  section  of  the  statement,  thereby  checking  the  cor- 
rectness of  the  work. 

The  example  given  above  is  a  very  simple  one,  so  simple 
that  the  reader  may  be  inclined  to  think  that  the  principles 
which  apply  to  a  little  example  like  this  are  not  sufficient 
to  cover  the  great  variety  of  operations  which  arise  in  practice. 
But  as  a  matter  of  fact  the  example  is  complete.  It  illustrates 
how  to  open  the  books,  how  to  record  contributions,  with- 
drawals and  transactions,  how  to  close  the  books,  how  to 
re-open  them,  and  how  to  make  a  statement  of  the  results; 
and  that  is  all  that  there  is  to  double-entry  bookkeeping. 
So  far  as  the  principles  of  double-entry  bookkeeping  are 
concerned,  there  is  nothing  in  the  accounting  of  a  railroad 
company  or  of  a  great  industrial  corporation  which  is  not 
covered  by  this  example. 

To  be  sure,  the  example  does  not  mention  the  subject  of 
depreciation,  nor  does  it  discuss  the  question  whether,  at  the 
time  of  closing  the  books,  merchandise  should  be  valued  at 
its  cost  price  or  at  its  present  market  price,  nor  does  it  say 
anything  about  the  question  which  the  accountant  so  fre- 
quently raises,  as  to  whether  a  certain  outlay  should  be  con- 
sidered as  a  charge  to  construction  or  to  operation.  But  all 
such  matters  are  covered  by  the  statement  that  the  books  are 
closed  by  inventory;  and  to  take  inventory  means  to  appraise 
the  values  of  the  assets  and  liabilities. 

To  a  very  great  extent  accounting  necessarily  deals  with 
estimated  values.  There  are  no  absolute  values  in  bookkeep- 
ing, except  the  value  of  the  cash  on  hand  and  the  amount 
of  the  legal  liabilities;  all  other  values  are  estimated.  Even 


DOUBLE-ENTEY    BOOKKEEPING  127 

the  value  of  cash,  as  measured  by  what  it  will  buy,  varies; 
but  as  expressed  in  terms  of  money  it  cannot  vary,  and  in 
bookkeeping  all  values  are  expressed  in  terms  of  money. 

In  estimating  values  there  is  always  room  for  difference 
of  opinion.  In  the  case  of  a  personal  account  owed  to  the 
proprietor,  one  man  might  consider  it  good  and  another  might 
think  that  it  was  bad.  After  eliminating  all  the  debts  which 
are  known  to  be  bad,  one  man  might  think  that  the  others 
should  be  taken  at  their  face  value,  another  might  think  that 
three  per  cent  should  be  deducted  for  possible  failures  to 
collect,  and  another  might  think  that  five  per  cent  should 
be  deducted.  In  the  case  of  a  manufacturing  plant  which 
has  been  in  use  for  some  time,  one  man  might  think  that  it 
is  still  worth  what  it  cost,  while  another  might  think  that 
an  allowance  should  be  made  for  depreciation.  In  the  case 
of  a  certain  outlay,  one  man  might  think  that  it  should  be 
regarded  as  an  investment,  and  another  might  think  that  it 
should  be  regarded  as  an  expense. 

All  such  matters  are  questions  of  accounting  in  general, 
but  they  are  not  questions  of  double-entry  bookkeeping  in 
particular;  that  is  to  say,  they  do  not  involve  any  principle 
of  double-entry  bookkeeping  as  distinguished  from  single- 
entry  bookkeeping.  They  are  matters  of  opinion  and  of 
judgment,  and  therefore  they  must  be  settled  by  authority — 
either  by  the  authority  of  the  proprietor  of  the  business  or 
by  the  authority  of  the  law. 


128 


PRINCIPLES    OF 


CHAPTER    XV 

THE   BALANCE   SHEET. 

Frequent  closing  of  the  ledger  is  inconvenient  and  unneces- 
sary. All  the  information  which  is  brought  out  by  that 
operation  can  be  obtained  just  as  well  by  doing  the  work  on 
a  separate  sheet  (called  the  "balance  sheet")  leaving  the 
ledger  accounts  open.  It  is  only  when,  for  some  reason,  it  is 
considered  desirable  to  make  a  permanent  record  in  the 
ledger  of  the  state  of  affairs  at  a  certain  date,  that  it  is 
worth  while  to  close  the  accounts. 

To  illustrate  the  construction  of  the  balance  sheet,  we 
will  repeat  the  ledger  accounts  of  the  example  given  in  the 
preceding  chapter,  omitting  the  closing  entries  and  trans- 
ferring the  totals  of  the  debits  and  credits  to  the  statement 
which  is  known  as  the  "trial  balance." 

LEDGER  ACCOUNTS. 


Dr.                   Cash                    Cr. 
To  Proprietor 

Dr.            Merchandise            Cr. 
To  Proprietor 

(1)     $3,000 
(5)       5,700 
(9)       2,900 

(8)     $300 
(12)       400 
(14)       200 

(2)     $10,000 

(6)     $5,700 
(10)       2,900 

Dr.           Bills  Payable           Cr. 
To  Proprietor 

Dr.               Expense                Cr. 
To   Proprietor 

(11)     $400 

(3)     $1,000 

(7)     $300 

Dr.             Proprietor              Cr. 
To  Outside  Parties 

(13)     $200  II       (4)     $12,000 

1 

DOTJBLE-ENTKY   BOOKKEEPING 


129 


TRIAL  BALANCE 


LEDGER 

ACCOUNTS 

Total 
Debits 

Total 
Credits 

Net 
Debits 

Net 
Credits 

Cash 

$11  600 

$900 

$10700 

Merchandise 

10000 

8  600 

1  400 

Bills  Payable  

400 

1  000 

$600 

Expense  

300 

300 

Proprietor 

200 

12000 

11  800 

TOTALS  

$22  500 

$22  500 

$12  400 

$12,400 

If  the  totals  of  the  debits  and  credits  balance,  then,  of 
course,  the  totals  of  the  net  debits  and  net  credits  must 
balance,  since  in  each  case  the  net  debit  or  net  credit  is 
obtained  by  subtracting  the  same  amount  from  both  sides. 
The  fact  that  the  totals  of  the  debits  and  credits  balance  is 
not  positive  proof  that  the  ledger  is  correct,  but  it  is  what  a 
lawyer  would  call  prima  facie  evidence  to  that  effect;  in  the 
absence  of  any  evidence  to  the  contrary,  it  indicates  that  the 
ledger  is  correct.  If  the  totals  of  the  debits  and  credits  do 
not  balance,  it  is  positive  proof  that  something  is  wrong. 

The  balance  sheet  given  below  contains  six  columns,  two 
showing  the  net  debits  and  net  credits  of  the  ledger  accounts 
at  the  time  of  making  the  statement,  two  showing  the  assets, 
liabilities  and  net  capital  as  determined  by  inventory  at  that 
time,  and  two  showing  the  excess  debits  and  excess  credits 
obtained  by  combining  the  preceding  columns. 

In  this  country,  and  in  most  other  countries,  the  book- 
keeper's statement  of  assets  and  liabilities  (which  is  simply 
the  inventory)  shows  the  amounts  of  the  assets  on  the  debit 
side  and  the  amounts  of  the  liabilities  on  the  credit  side ;  but 
in  England  it  is  customary  to  make  the  statement  the  other 
way.  Now  at  the  close  of  the  period  the  amounts  of  the 
assets  are  entered  as  credits  and  the  amounts  of  the  liabilities 
are  entered  as  debits;  but  at  the  beginning  of  the  new  period 


130 


PRINCIPLES    OF 


the  amounts  of  the  assets  are  entered  as  debits  and  the 
amounts  of  the  liabilities  are  entered  as  credits.  The 
English  method,  then,  shows  the  entries  as  made  at  the  end 
of  the  closing  period,  while  the  other  method  shows  them  as 
made  at  the  beginning  of  the  new  period.  On  the  balance 
sheet  the  inventory  is  given  according  to  the  English  method, 
and  necessarily  so,  because,  if  we  are  to  determine  the  losses 
and  gains  of  the  closing  period,  we  must  take  the  entries  as 
made  at  the  end  of  that  period. 

It  will  be  noted  that  in  the  balance-sheet  form  the  head- 
ings in  parentheses  apply  only  to  the  accounts  of  original 
entry;  they  must,  of  course,  be  reversed  when  applied  to  the 
account  of  duplicate  entry,  since  in  that  account  as  compared 
with  the  others  the  relative  position  of  the  proprietor  and  the 
outside  parties  is  reversed. 

BALANCE  SHEET 


LEDGER  ACCOUNTS 

INVENTORY 

Excess 
Debits 
Lo.-ses) 

Excess 
Credits 
Gains! 

Net 
Debits 

Net 
Credits 

Debits 
(Lia- 
bilities) 

Credits 

(Assets) 

I 

II 

in 

IV 

V 

VI 

Cash  /  

$10,700 

.... 

$10,700 

.... 

Merchandise  

1,400 





2,500 

$1,100 

Bills  Payable  



$600 

$600 

Expense 

300 





$300 

— 

Proprietor  

11,800 

Net 

Asset 
12,600 

Net 
Gain 
800 

TOTALS  

$12,400 

$12,400 

$13,200 

$13,200 

$1,100 

$1,100 

The  process  illustrated  by  this  example  is  applicable  to 
any  set  of  books,  no  matter  how  extensive  they  may  be. 
Every  account  in  the  books  of  a  railroad  company,  for 
instance,  can  be  shown  on  the  balance  sheet;  but  in  practice 


DOUBLE-ENTRY   BOOKKEEPING  131 

the  items  would  be  condensed  under  general  headings  in  order 
to  keep  the  size  of  the  balance  sheet  within  reasonable  limits. 
We  can,  of  course,  close  the  ledger  and  then  make  the  balance 
sheet,  or  we  can  make  the  balance  sheet  and  then  close  the 
ledger,  or  we  can  make  the  balance  sheet  without  closing  the 
ledger,  that  is  to  say,  we  can  close  the  accounts  on  the  balance 
sheet  and  leave  them  open  in  the  ledger. 

The  above  balance  sheet  is  exactly  in  accordance  with  the 
method  of  closing  the  books  prescribed  by  the  theory  and 
illustrated  by  the  example  given  in  Chapter  XIV. 

In  cash  account  the  amount  of  the  asset  as  determined  by 
inventory  is  $10,700.  This  amount  is  entered  as  a  credit  to 
close  the  old  account  and  as  a  debit  to  open  the  new  account. 
Since  the  balance  sheet  deals  only  with  the  old  accounts,  the 
$10,700  is  entered  as  a  credit  in  Column  IV.  The  debit  in 
Column  I  is  also  $10,700,  therefore  the  account  shows  no 
excess  debit  or  credit. 

In  merchandise  account  the  amount  of  the  asset  as  deter- 
mined by  inventory  is  $2,500.  This  amount  is  entered  as  a 
credit  to  close  the  old  account  and  as  a  debit  to  open  the  hew 
account,  therefore  it  is  entered  as  a  credit  in  Column  IV. 
The  debit  in  Column  I  is  $1,400,  therefore  the  account  shows 
an  excess  credit  of  $1,100,  which  represents  gain  due  to 
dealing  in  merchandise. 

In  bills  payable  account  the  amount  of  the  liability  as 
determined  by  inventory  is  $600.  This  amount  is  entered  as 
a  debit  to  close  the  old  account  and  as  a  credit  to  open  the 
new  account,  therefore  it  is  entered  as  a  debit  in  Column  III. 
The  credit  in  Column  II  is  also  $600,  therefore  the  account 
shows  no  excess  debit  or  credit. 

In  expense  account  the  amount  of  the  asset  as  determined 
by  inventory  is  zero.  This  amount  would  be  entered  as  a 
credit  to  close  the  old  account  and  as  a  debit  to  open  the  new 
account,  but  since  the  amount  is  zero  it  is  unnecessary  to 
enter  it.  The  debit  in  Column  I  is  $300,  therefore  the  account 


132  PRINCIPLES    OF 

shows  an  excess  debit  of  $300,  which  represents  loss  due  to 
expense. 

In  the  proprietor's  account  the  amount  of  the  net  asset 
as  determined  by  inventory  is  $12,600.  This  amount  is 
entered  as  a  debit  to  close  the  old  account  and  as  a  credit  to 
open  the  new  account,  therefore  it  is  entered  as  a  debit  in 
Column  III.  Since  the  credit  in  Column  II  is  $11,800,  the 
account  shows  an  excess  debit  of  $800,  which  represents  the 
net  gain. 

The  check  on  the  correctness  of  the  work  lies  in  the  fact 
that  when  the  $800  is  entered  in  Column  V,  Columns  V  and 
VI  balance. 

The  form  of  balance  sheet  illustrated  above  (and  it  is 
the  only  correct  form)  is  so  simple  that  one  would  naturally 
suppose  that  it  would  occur  to  every  person  who  is  at  all 
familiar  with  the  art  of  accounting;  it  is  nothing  more  than 
a  tabulation  of  the  entries  which  every  bookkeeper  makes 
when  he  closes  his  books.  But  in  order  that  the  reader  may 
have  some  idea  as  to  how  little  intelligence  is  used  in  book- 
keeping, I  will  say  that  I  have  read  a  number  of  treatises  on 
the  subject  and  have  had  occasion  to  observe  the  work  of  a 
number  of  bookkeepers,  yet  I  have  never  seen  a  text-book 
that  gave,  nor  have  I  ever  met  a  bookkeeper  who  knew  how 
to  make,  a  proper  form  of  balance  sheet.  What  the  book- 
keeper commonly  calls  his  "balance  sheet"  is  simply  the 
inventory  given  in  Columns  III  and  IV  of  our  example.  As 
to  the  relations  between  those  figures  and  the  net  debits  and 
net  credits  of  his  ledger  accounts,  apparently  he  has  not  the 
remotest  conception. 

The  balance  sheet  gives  all  the  information  which  is 
usually  regarded  as  essential  in  bookkeeping;  but  if  it  were 
thought  worth  while,  a  similar  statement  could  be  made  show- 
ing the  relation  between  the  inventory  at  the  beginning  and 


DOUBLE-ENTKY    BOOKKEEPING 


133 


the  inventory  at  the  close  of  the  period.  The  process  is  based 
upon  the  fact  that  at  the  beginning  the  amounts  of  the  assets 
are  entered  as  debits  and  the  amounts  of  the  liabilities  and  the 
net  asset  are  entered  as  credits,  while  at  the  close  of  the 
period  the  amounts  of  the  assets  are  entered  as  credits  and 
the  amounts  of  the  liabilities  and  the  net  asset  are  entered 
as  debits.  In  our  example,  then,  the  statement  would  be  as 
follows : 


INVENTORY  AT 
BEGINNING 

INVENTORY  AT 
CLOSE 

Excess 
Debits 
(Outgo) 

Excess 
Credits 
(Income) 

Debits 

(Assets) 

Credits 
(Lia- 
bilities) 

Debits 

(Lia- 
bilities) 

Credits 

(Assets) 

Cash  

$3,000 

.... 

.... 

$10,700 

.... 

$7,700 

Merchandise  

10,000 



2,500 

$7,500 

Bills  Payable 

$1,000 

$600 



400 

Proprietor  

Net 
Asset 
12,000 

Net 
Asset 
12,600 

Net 
Income 
600 

TOTALS  

$18,000 

$13,000 

$13,200 

$13,200 

$8,100 

$8,100 

This  statement  means  that  during  the  period  there  was 
an  increase  of  asset  in  the  form  of  cash  to  the  amount  of 
$7,700,  a  decrease  of  asset  in  the  form  of  merchandise  to  the 
amount  of  $7,500,  an  increase  of  asset  (decrease  of  liability) 
in  the  form  of.  bills  payable  to  the  amount  of  $400,  and  a 
net  increase  of  asset  to  the  amount  of  $600.  During  the 
period  the  owner  drew  out  $200  for  personal  use;  if  he  had 
not  withdrawn  anything  the  net  increase  of  asset  would  have 
been  $800,  the  amount  of  the  net  gain. 

In  algebraical  form,  the  relations  between  the  inventory 
at  the  beginning  and  the  inventory  at  the  close  of  the  period 
are  shown  in  the  following  statement: 
10 


134 


PRINCIPLES    OF 


A 

Inventory  at 
Close 

B 

Inventory  at 
Beginning 

o 

Differences 
(Income 
and  Outgo) 

Cash 

$10700 

$3000 

$7  700 

Merchandise 

2  500 

10  000 

—  7  500 

Bills  Payable 

—  600 

1  000 

400 

TOTALB  

Net 
Asset  $12  600 

Net 
Asset     $12  000 

Net 
Income     $600 

In  this  statement  assets  are  positive  and  liabilities  are 
negative,  and  in  each  case  the  item  in  Column  C  is  obtained 
by  subtracting  the  item  in  Column  B  from  the  corresponding 
item  in  Column  A.  When  the  difference  is  positive  it  repre- 
sents income  and  when  negative  it  represents  outgo. 

The  statement  in  algebraical  form  corresponding  to  the 
balance  sheet  is  as  follows: 


A 

Inventory  at 
Close 

B' 

Net  Debits  and 
Net  Credits 
at  Close 

C' 

Differences 
(Gains  and  Losses) 

Cash 

$10  700 

$10  700 

Merchand  ise 

2  500 

1  400 

$1  100 

Bills  Payable  

—600 

—600 

Expense.        

300 

—300 

TOTALS 

Net 
Asset  $12  600 

Net 
Debit  $11  800 

Net 
Gain          $800 

In  this  case  assets  and  net  debits  are  positive  and  liabilities 
and  net  credits  are  negative.  When  the  result  obtained  by 
subtracting  an  item  in  Column  B'  from  the  corresponding 
item  in  Column  A  is  positive  it  represents  gain,  and  when 
negative  it  represents  loss. 


DOUBLE-ENTRY   BOOKKEEPING  135 

The  total  of  Column  B'  ($11,800)  is  the  net  debit  of  the 
accounts  of  original  entry,  and  therefore  it  is  the  net  credit 
of  the  account  of  duplicate  entry,  since  in  that  account,  as 
compared  with  the  others,  the  relative  position  of  the  pro- 
prietor and  the  outside  parties  is  reversed. 

Comparing  the  last  two  statements  the  reader  will  observe 
that  the  difference  between  the  totals  of  Columns  C  and  C' 
must  always  be  the  same  as  the  difference  between  the  totals 
of  Columns  B  and  B',  since  Column  A  is  the  same  in  both 
statements.  Now,  the  total  of  Column  B  shows  what  the  net 
capital  was  at  the  beginning,  and  the  total  of  Column  B'  shows 
what  the  net  capital  would  be  at  the  close  if  there  were  no 
loss  nor  gain,  that  is  to  say,  it  shows  what  the  net  capital 
would  be  if  there  were  no  changes  in  it  except  those  due  to 
contributions  and  withdrawals.  The  totals  of  Columns  B 
and  B',  then,  always  differ  by  the  net  amount  contributed  or 
withdrawn  during  the  period  and  therefore  the  totals  of 
Columns  C  and  C'  always  differ  by  that  amount.  In  other 
words,  the  net  income  or  outgo  and  the  net  gain  or  loss 
always  differ  by  the  net  amount  contributed  or  withdrawn. 


136  PRINCIPLES    OP 


CHAPTER   XVI 

RULES    FOR   KEEPING  BOOKS   BY   THE   DOUBLE-ENTRY    METHOD. 

The  theory  given  in  Chapter  XIII  covers  the  whole  field 
oJLdouble-entry  bookkeeping.  |  Guided  by  the  theory  alone  the 


accountant  could  record  every  case  which  can  possibly  arise 
in  practice,  and  record  it  correctly.     But  there  is  this  diffi- 
culty :  To  use  the  theory  as  a  guide  one  must  imagine  himself 
as  engaged  in  transactions  with  fictitious  persons,  and  the 
bookkeeper's  work  is  of  so  prosaic  a  nature  that  it  tends  to 
repress  rather  than  to  stimulate  the  exercise  of  the  imagina- 
tion.   So  far  as  the  routine  task  of  keeping  books  is  concerned, 
the  important  thing  is  to  know,  or  to  be  able  to  determine 
quickly,  how  to  make  the  entries  in  any  given  case,  without 
stopping  to  reason  it  out.    Therefore  for  practical  purposes  it 
is  convenient  to  have  a  set  of  rules  embodying  that  part  of 
the  theory  which  answers  the  question  "how,"  but  leaving  out      .  \ 
the  imaginative  part,  the  part  which  answers  the  question     -•/ 
"why."     In  order  to  devise  such  a  set  of  rules  all  that  is     A 
needed  is  to  follow  the  line  of  reasoning  developed  in  the  v  /\- 
theory.  ,  J^  \ 

To  open  the  books : 

The  aslieTs~~and  liabilities  are  determined  by  inventory. 
According  to  the  theory,  the  owner  as  an  outside  party  trans- 
fers to  the  owner  as  proprietor  the  amounts  of  the  assets,  and 
the  proprietor  lends  these  amounts  to  the  parties  whose  names 
indicate  the  form  of  the  assets.  The  owner  as  proprietor 
borrows  the  amounts  of  the  liabilities  from  the  parties  whose 
names  indicate  the  form  of  the  liabilities,  and  transfers  these 
amounts  to  the  owner  as  an  outside  party.  All  of  the  debts 
resulting  from  these  operations  are  recorded  in  duplicate,  but 
to  the  extent  to  which  the  duplicate  entries  cancel  each  other 
they  are  omitted. 


DOUBLE-ENTKY    BOOKKEEPING  137 

Leaving  out  the  imaginative  part  of  it,  the  above  state- 
ment means  simply  that  to  open  the  books  we  debit  the 
amounts  of  the  assets  to  the  parties  whose  names  indicate  the 
form  of  the  assets,  credit  the  amounts  of  the  liabilities  to  the 
parties  whose  names  indicate  the  form  of  the  liabilities,  and 
credit  the  proprietor  with  the  excess  of  assets  over  liabilities 
or  debit  him  with  the  excess  of  liabilities  over  assets. 
^  The  next  stage  of  the  process  is  to  record  in  the  order 
of  their  occurrence  the  various  financial  operations  in  which 
the  proprietor  of  the  business  takes  part,  and  these  operations 
consist  of  contributions,  withdrawals  and  transactions. 

To  record  a  contribution: 

According  to  the  theory,  the  owner  as  an  outside  party 
transfers  to  the  owner  as  proprietor  the  amount  of  the  con- 
tribution and  the  proprietor  lends  it  to  the  party  whose  name 
indicates  the  form  of  the  income,  the  debt  resulting  from  the 
operation  being  recorded  in  duplicate.  Therefore,  to  record 
a  contribution  we  debit  the  party  whose  name  indicates  the 
form  of  the  income  and  credit  the  proprietor. 

To  record  a  withdrawal : 

According  to  the  theory,  the  owner  as  proprietor  borrows 
the  amount  of  the  withdrawal  from  the  party  whose  name 
indicates  the  form  of  the  outgo  and  transfers  it  to  the  owner 
as  an  outside  party,  the  debt  resulting  from  the  operation 
being  recorded  in  duplicate.  Therefore,  to  record  a  with- 
drawal we  credit  the  party  whose  name  indicates  the  form  of 
the  outgo  and  debit  the  proprietor. 

To  record  a  transaction: 

In  the  case  of  a  transaction  we  are  supposed,  according 
to  the  theory,  to  'borrow  the  amount  from  A  and  to  lend  it  to 
B.  In  other  words,  A  is  supposed  to  lend  the  amount  to  us 
and  B  is  supposed  to  borrow  it  from  us.  When  a  person 
lends  to  us  he  causes  income,  and  the  debt  which  we  owe 
him  (assuming  it  to  be  good)  represents  the  corresponding 


138  PRINCIPLES    OF  \,  V 

/r 

outgo.    When  a  person  borrows  from  us  he  causes  outgo,  and 

the  debt  which  he  owes  us  (assuming  it  to  be  good)  represents 
the  corresponding  income.  On  the  assumption,  then,  that  all 
debts  are  good  at  the  time  when  they  are  contracted,  a  debit 
to  an  outside  party  represents  income  in  the  form  indicated 
by  the  heading  of  the  account  and  outgo  caused  by  the  head- 
ing of  the  account,  and  a  credit  represents  outgo  in  the  form 
indicated  by  the  heading  of  the  account  and  income  caused 
by  the  heading  of  the  account.  Each  entry  has  two  meanings, 
the  one  concrete  and  the  other  abstract. 

As  long  as  the  debts  are  good  there  can  be  no  loss  nor 
gain  in  borrowing  and  lending,  and  in  double-entry  bookkeep- 
ing a  transaction  is  simply  a  matter  of  borrowing  something 
from  one  party  and  lending  it  to  another.  Lit  follows,  there- 
fore, that  transactions  must  be  recorded  on  the  assumption 
that  there  is  no  loss  nor  gain,  that  outgo  and  income  are 
equal  in  every  case.  In  every  transaction,  then,  we  are  sup- 
posed to  give  and  to  receive  the  same  amount,  and  the  two 
actions  may  be  regarded  as  mutually  causing  each  other; 
we  give  because  we  receive  and  we  receive  because  we  give; 
the  income  causes  the  outgo  and  the  outgo  causes  the  income ; 
the  entry  which  records  the  form  of  the  income  also  records 
the  cause  of  the  outgo,  and  the  entry  which  records  the  form 
of  the  outgo  also  records  the  cause  of  the  income. 

But  although  every  entry  has  a  double  meaning,  the  two 
meanings  are  not  always  equally  evident.  When  we  record  a 
disbursement  of  money  for  expenses  by  crediting  Cash  and 
debiting  Expense,  it  is  very  evident  that  we  credit  Cash  to 
show  the  form  of  the  outgo  and  debit  Expense  to  show  the 
cause  of  the  outgo.  It  is  equally  true,  but  not  so  evident, 
that  we  debit  Expense  to  show  the  form  of  the  income  and 
credit  Cash  to  show  the  cause  of  the  income. 

At  first  thought  one  might  question  the  statement  that 
a  debit  to  Expense  means  income,  increase  of  asset;  but  the 
very  form  of  the  account  gives  it  that  meaning. 


DOUBLE-ENTRY   BOOKKEEPING  139 

Cash  account  is  in  this  form: 

Dr.  Cash  Cr. 

To  Proprietor 


Expense  account  is  in  this  form : 

Dr.  Expense  Cr. 

To  Proprietor 


A  debit  to  Cash  means  increase  of  debt  owed  to  the  pro- 
prietor by  Cash;  a  debit  to  Expense  means  increase  of  debt 
owed  to  the  proprietor  by  Expense.  If  one  of  these  entries 
means  increase  of  asset,  the  other  does  also;  if  all  debts  are 
good,  a  debit  to  Expense  is  just  as  good  an  asset  as  a  debit 
to  Cash.  The  point  to  be  observed  is  this:  We  make  the 
entries  on  the  assumption  that  all  debts  are  good;  but  when 
we  come  to  close  the  accounts  we  drop  that  assumption  and 
appraise  the^values  of  the  debts. 

To  record  a  transaction,  then,  we  debit  the  party  whose 
name  indicates  the  form  of  the  income  and  the  cause  of  the 
outgo,  and  credit  the  party  whose  name  indicates  the  form 
of  the  outgo  and  the  cause  of  the  income.  But  since  the  two 
meanings  are  not  always  equally  evident,  the  bookkeeper  will 
be  guided  by  the  one  which  is  the  more  evident  in  each  par- 
ticular case,  and  therefore  for  practical  purposes  it  is  more 
convenient  to  put  the  statement  in  this  form :  /f  To  record  a 
transaction  we  debit  the  party  whose  name  indicates  the 
form  of  the  income  or  the  cause  of  the  outgo,  and  credit  the 


140  PRINCIPLES    OF 

party  whose  name  indicates  the  form  of  the  outgo  or  the 
cause  of  the  income. 

To  close  the  books : 

The  assets  and  liabilities  are  again  determined  by  inven- 
tory. According  to  the  theory,  the  owner  as  proprietor 
borrows  the  amounts  of  the  assets  from  the  parties  whose 
names  indicate  the  form  of  the  assets,  and  transfers  them  to 
the  owner  as  an  outside  party.  The  owner  as  an  outside 
party  transfers  to  the  owner  as  proprietor  the  amounts  of 
the  liabilities  and  the  proprietor  lends  them  to  the  parties 
whose  names  indicate  the  form  of  the  liabilities.  All  of  the 
debts  resulting  from  these  operations  are  recorded  in  dupli- 
cate, but  to  the  extent  to  which  the  duplicate  entries  cancel 
each  other  they  are  omitted. 

Leaving  out  the  imaginative  part  of  it,  the  above  state- 
ment means  that  to  close  the  books  we  credit  the  amounts 
of  the  assets  to  the  parties  whose  names  indicate  the  form  of 
the  assets,  debit  the  amounts  of  the  liabilities  to  the  parties 
whose  names  indicate  the  form  of  the  liabilities,  and  debit 
the  proprietor  with  the  excess  of  assets  over  liabilities  or 
credit  him  with  the  excess  of  liabilities  over  assets. 

After  these  entries  have  been  made,  then,  in  every  account 
of  original  entry  the  debits  show  the  amounts  which  we  have 
given  to  the  party  whose  name  heads  the  account  and  the 
credits  show  the  amounts  which  we  have  received  from  him; 
therefore  an  excess  debit  represents  a  loss  and  an  excess 
credit  represents  a  gain.  In  the  account  of  duplicate  entry 
the  debits  show  the  amounts  which  we  have"  received  from  the 
outside  parties  collectively,  and  the  credits  show  the  amounts 
which  we  have  given  to  them;  therefore  an  excess  debit 
represents  the  net  gain,  an  excess  credit  represents  the  net 
loss.  To  record  the  losses  and  gains  and  the -net  loss  or  net 
gain  we  balance  all  of  the  accounts. 

The  books  are  now  re-opened  in  the  same  way  in  which 


DOUBLE-ENTRY   BOOKKEEPING  141 

they  were  opened  in  the  first  place,  and  therefore  it  is  unneces- 
sary to  repeat  the  discussion. 

In  accordance  with  the  ideas  developed  above,  the  rules 
for  keeping  books  by  the  double-entry  method  are  as  follows : 

To  open  the  books: 

Take  an  inventory  of  the  assets  and  liabilities. 

Debit  the  amounts  of  the  assets  to  the  parties  whose 
names  indicate  the  form  of  the  assets  and  credit  the  amounts 
of  the  liabilities  to  the  parties  whose  names  indicate  the 
form  of  the  liabilities. 

Credit  the  proprietor  with  the  excess  of  assets  over 
liabilities  or  debit  him  with  the  excess  of  liabilities  over 
assets. 

To  record  a  contribution: 

Debit  the  party  whose  name  indicates  the  form  of  the 
income  and  credit  the  proprietor. 

To  record  a  withdrawal: 

Credit  the  party  whose  name  indicates  the  form  of  the 
outgo  and  debit  the  proprietor. 

To  record  a  transaction: 

Debit  the  party  whose  name  indicates  the  form  of  the 
income  or  the  cause  of  the  outgo  and  credit  the  party  whose 
name  indicates  the  form  of  the  outgo  or  the  cause  of  the 
income. 

To  close  the  books : 

Take  another  inventory  of  the  assets  and  liabilities. 

Credit  the  amounts  of  the  assets  to  the  parties  whose 
names  indicate  the  form  of  the  assets  and  debit  the  amounts 
of  the  liabilities  to  the  parties  whose  names  indicate  the  form 
of  the  liabilities. 

Debit  the  proprietor  with  the  excess  of  assets  over  lia- 
bilities or  credit  him  with  the  excess  of  liabilities  over  assets. 

After  these  entries  have  been  made,  then,  in  every  account 
of  original  entry  an  excess  debit  represents  a  loss,  an  excess 


142 


PRINCIPLES    OF 


credit  represents  a  gain ;  in  the  account  of  duplicate  entry  an 
excess  debit  represents  the  net  gain,  an  excess  credit  repre- 
sents the  net  loss.  To  record  the  losses  and  gains  and  the 
net  loss  or  net  gain,  balance  all  of  the  accounts. 

The  check  on  the  correctness  of  the  work  lies  in  the  fact 
that  the  net  loss  or  net  gain  as  determined  by  the  account 
of  duplicate  entry,  must  agree  with  the  aggregate  of  the 
losses  and  gains  as  determined  by  the  accounts  of  original 
entry. 

The  rule  for  opening  the  books  is  now  applied  again  and 
the  work  proceeds  as  before. 

In  stating  the  rules  we  assume  that  the  proprietor  is  an 
individual.  In  the  case  of  a  firm  or  a  company,  when  we 
speak  of  debiting  or  crediting  the  proprietor  we  mean  that  we 
debit  or  credit  one  or  more  of  the  accounts  in  which  the 
proprietor,  that  is  to  say,  the  firm  or  the  company,  is  the 
first  party  (partnership  accounts  and  accounts  like  Capital 
Stock  and  Surplus). 

The  above  rules  are  exactly  in  accordance  with  the  theory 
given  in  Chapter  XIII;  and  if  the  reader  will  turn  to  the 
example  given  in  Chapter  XIV,  he  will  find  that  the  entries 
are  made  exactly  in  accordance  with  the  rules. 

But  in  practice  the  bookkeeper  does  not  close  the  books 
according  to  the  method  prescribed  by  the  theory;  he  always 
closes  the  accounts  of  duplicate  entry  backwards.  To  explain 
what  we  mean  by  that  statement,  we  will  repeat  the  pro- 
prietor's account  in  the  example  given  in  Chapter  XIV,  which 
is  as  follows: 


Dr. 


Proprietor 

To  Outside  Parties 


Cr. 


Bal.   (Invty.) 

(13)       $200 
(15)     12,600 

Inventory 
Excess  Debit 

(4)    $12,000 
(Net  Gain)     800 

$12,800 

$12,800 

Bal.   (Invty.) 

(22)   $12,600 

DOUBLE-ENTKY   BOOKKEEPING  143 

According  to  the  theory,  and  according  to  the  rules  given 
above,  the  amount  of  the  net  asset  as  determined  by  inventory 
at  the  close  of  the  period  ($12,600)  is  entered  in  the  old 
account,  and  then  the  excess  debit  ($800)  represents  the 
net  gain.  In  other  words,  the  amount  of  the  net  asset 
($12,600)  is  entered  first,  and  then  the  amount  of  the  net 
gain  ($800)  is  determined  by  difference;  and  this  must 
agree  with  the  net  gain  as  determined  by  the  accounts  of 
original  entry  (a  gain  of  $1,100  in  merchandise  account  and 
a  loss  of  $300  in  expense  account). 

But  it  is  evident  that  we  can  arrive  at  the  same  result  by 
doing  the  work  backwards;  that  is  to  say,  the  amount  of  the 
net  gain  as  determined  by  the  accounts  of  original  entry 
($800)  can  be  entered  first,  and  then  the  amount  of  the  net 
asset  ($12,600)  is  determined  by  difference,  and  this  must 
agree  with  the  amount  of  the  net  asset  as  determined  by 
inventory.  In  practice,  that  is  the  way  in  which  the  book- 
keeper always  does  it,  and  to  facilitate  the  operation  he 
makes  his  statement  of  losses  and  gains  in  the  ledger,  usually 
under  the  heading  "Profit  and  Loss/'  To  adapt  the  rules 
to  the  methods  which  are  used  in  practice,  all  that  is  needed 
is  to  change  the  rule  for  closing  the  books  so  as  to  make  it 
read  as  follows : 

To  close  and  re-open  the  books : 

Take  another  inventory  of  the  assets  and  liabilities.  Enter 
the  amounts  of  the  assets  as  credits  to  the  parties  whose 
names  indicate  the  form  of  the  assets,  and  carry  them  down 
to  new  account  as  debits ;  enter  the  amounts  of  the  liabilities 
as  debits  to  the  parties  whose  names  indicate  the  form  of  the 
liabilities,  and  carry  them  down  to  new  account  as  credits. 
Then,  in  every  account  of  original  entry  an  excess  debit 
represents  a  loss,  an  excess  credit  represents  a  gain.  Trans- 
fer the  losses  and  gains  to  Profit  and  Loss,  transfer  the  net 
loss  or  net  gain  to  the  accounts  of  duplicate  entry,  close  these 


144  PRINCIPLES    OF 

accounts  by  balance  and  carry  the   balances   down  to  new 
account. 

In  this  case,  the  check  on  the  correctness  of  the  work  lies 
in  the  fact  that  after  all  of  the  accounts  have  been  closed 
the  total  of  the  balances  brought  down  as  debits  must  agree 
with  the  total  of  the  balances  brought  down  as  credits. 


DOUBLE-ENTRY  BOOKKEEPING 


145 


CHAPTER   XVII 

EXAMPLE    ILLUSTRATING   THE    RULES — PROFIT    AND   LOSS. 

To  illustrate  the  methods  which  are  used  in  practice  we 
will  repeat  the  example  given  in  Chapter  XIV,  but  will 
assume  that  the  proprietor,  instead  of  being  an  individual, 
is  the  firm  of  Smith  &  Jones,  who  are  equal  partners  and 
contribute  equal  amounts  at  the  beginning. 

STATEMENT  OP  THE  EXAMPLE. 
Inventory  at  the  beginning: 


ASSETS 

LIABILITIES 

Cash 

$3  000 

Bills   Payable    

.  .  .  $1,000 

*    *  *  *    .     *  *  ' 

~f 

flour 

(5)    $5  00) 

10  000 

Total             ... 

$1,000 

Bal.   (Net  Capital)    . 

...   12,000 

Total 

$13,000 

$13,000 

Transactions : 

1st.    They  sell  1,000  barrels  of  flour  @  $5.70  $5,700 

2nd.  They  pay  out  $300  for  expenses  300 

3rd.  They  sell  500  barrels  of  flour  @  $5.80  2,900 

4th.  They  pay  one  of  their  notes  400 

Withdrawal: 

Smith  draws  out  $200  for  personal  use   200 


Inventory  at  close: 


ASSETS 

LIABILITIES 

Cash    

...$10,700 

Bills  Payable    

.  .      $600 

Mdse.     (500    barrels 
flour  @  $5.00)    .  .  . 

of 

.  .  .     2,500 

Total    

$600 

Bal.   (Net  Capital)    .. 

..  12,600 

Total    

...$13,200 

$13,200 

The  entries  given  below  simply  follow  the  rules  stated 
in  the  preceding  chapter  and  therefore  need  no  further 
explanation. 


146 


PRINCIPLES    OF 

JOUBNAL 


Dr. 


Cr. 


To    Open 

Cash    to  Finn      .  .  . 

(1) 

$3000 

the  books 

(2) 

10,000 

Bills  Payable,   to   Firm    
Firm    (John  Smith),  to  Out- 
side   Parties    

(3) 

(4) 

$1,000 
6,000 

Firm    (Win.   Jones),   to  Out- 
side   Parties 

(5) 

6,000 

1st   Trans- 

Cash, to  Firm    

(6) 

5,700 

action 

Merchandise,  to  Firm 

(?) 

5,700 

2nd  Trans- 

Expense, to  Firm  

(8) 

300 

action 

Cash,   to  Firm    

(0) 

300 

3rd  Trans- 

Cash   to  Firm 

(10) 

2900 

action 

Merchandise    to  Firm 

(11) 

2,900 

4th   Trans- 
action 

Bills  Payable,  to  Firm   
Cash    to  Firm 

(12) 
(13) 

400 

400 

Withdrawal 

Firm    (John  Smith),  to  Out- 
side   Parties    

(14) 

200 

Cash,  to  Firm             

(15) 

200 

Cash      (New     Account),     to 
Firm    

(1C) 

10,700 

Cash  (Old  Account),  to  Firm 

(17) 

10,700 

Mdse.      (New     Account),     to 
Firm 

(18) 

2500 

Mdse.      (Old     Account),     to 
Firm    

(19) 

2,500 

Transfer    of    gain    to    Profit 
and  Loss 
Merchandise 

(20) 

1  100 

Profit  and  Loss 

(21) 

1  100 

books 

Bills      Payable       (Old      Ac- 
count )     to   Firm          

(22) 

600 

Bills      Payable      (New      Ac- 
count)    to  Firm               .  . 

(23) 

600 

Transfer    of    loss    to    Profit 
and  Loss 
Profit  and  Loss  

(24) 

300 

Expense    

(25) 

300 

Transfer     of     net     gain     to 
partners'  accounts 
Profit  and  Loss   

(26) 

800 

Firm    (John    Smith) 

(27) 

400 

Firm   (Wm.  Jones)    

(28) 

400 

Firm       (John      Smith,      Old 
Acct),   to  Outside   Parties 
Firm      (John      Smith,      New 
Acct.),   to   Outside   Parties 
Firm       (Wm.       Jones,       Old 
Acct.).   to   Outside  Parties 
Firm       (Wm.      Jones,      New 
Acct.),   to   Outside   Parties 

(29) 
(30) 
(31) 
(32) 

6,200 
6,400 

6,200 
6,400 

DOUBLE-ENTRY   BOOKKEEPING 


147 


Dr. 


LEDGER 
Cash 

To  Firm 


Cr. 


Inventory 

(1)     $3,000 
(6)       6,700 
(10)       2,900 

(9)        $300 
(13)          400 
(15)          200 
Bal.    (Invty.)           (17)     10,700 

Total  Debits 

$11  600 

Total   Credits    $11,600 

Bal.   (Invty.) 

(16)  $10,700 

Dr. 


Merchandise 
To  Firm 


Cr. 


Inve 

To 
Exc. 

ntory 
tal  Debits 

(2) 

$10,000 

(7)     $5,700 
(11)       2,900 
Bal.    (Invty.)           (19)       2,500 

$10,000 
1,100 

Cdt.    (Gain) 

(20) 

$11,100 

Total  Credits    $11,100 

Bal. 

(Invty.) 

(18) 

$2,500 

Dr. 


Bills  Payable 
To  Firm 


Cr. 


Bal.   (Invty.) 

(12) 
(22) 

$400 
600 

Inventory 

(3) 

$1,000 

Total  Debits 

$1  000 

Total  Credits 

$1,000 

Bal.    (Invty.) 

(23) 

$600 

Dr. 


Expense 
To  Firm 


Cr. 


(8) 

$300 

Bxc. 

Dbt. 

(Loss) 

(25) 

$300 

Total 

Debits  . 

$300 

$300 

148 
Losses 

PRINCIPLES    OF 
PROFIT  AND  Loss 

Gains 

Expense 
Total  Losses 

(24)        $300 

Merchandise             (21) 

$1,100 

$300 

Bal.   (Net  Gain) 

(26)          800 

$1,100 

Total  Gains       

$1,100 

Dr. 

Firm  (John  Smith) 
To  Outside  Parties 

Or. 

Total  Debits   .  . 

(14)        $200 
$200 

Inventory                  (4) 
Net  Gain                   (27) 

$6,000 
400 

Bal.    (Net  Asset) 

(29)       6,200 

$6,400 

Total   Credits 

$6,400 

Bal.    (Net  Asset)    (30) 

$6.200 

Dr. 

Firm  (Wm.  Jones) 
To  Outside  Parties 

Cr. 

Bal.    (Net  Asset) 

(31)     $6,400 

Inventory                    (5) 
Net  Gain                   (28) 

$6,000 
400 

$6,400 

Total  Credits      .    ... 

$6,400 

Bal.    (Net  Asset)    (32) 

$6,400 

To  check  the  correctness  of  the  work  we  compare  the  total 
of  the  balances  brought  down  as  debits  with  the  total  of  the 
balances  brought  down  as  credits: 


DEBITS 

CEEDITS 

Cash 

$10,700 

Bills  Payable         .    .  . 

$600 

Merchandise 

2  500 

John    Smith 

6,200 

Wm.   Jones    

6,400 

Total 

$13,200 

Total    

.   $13,200 

It  will  be  noted  that  in  the  above  statement  the  heading 
"Debits"  applies  to  all  of  the  items  on  the  left-hand  side  and 


DOUBLE-ENTIIY   BOOKKEEPING 


149 


the  heading  "Credits"  applies  to  all  of  the  items  on  the 
right-hand  side. 

But  the  bookkeeper  makes  the  statement  in  this  form : 


ASSETS 

LIABILITIES 

Cash    

.  .   $10,700 

Bills  Payable    

$600 

Merchandise 

2,500 

John    Smith 

6  200 

Wm    Jones    

6  400 

Total 

.  .   $13  200 

Total    

$13  200 

That  form  is  evidently  wrong.  The  heading  "Assets" 
applies  to  all  of  the  items  on  the  left-hand  side,  but  the  head- 
ing "Liabilities"  applies  only  to  the  first  item  on  the  right- 
hand  side;  the  other  two  items  represent  net  asset.  The 
statement  should  be  made  as  follows: 


ASSETS 

LIABILITIES 

Cash 

.     $10,700 

Bills  Payable    

$600 

TVTprrha.il  disc 

2  500 

Total 

$600 

Bal.   (Net  Capital)    ... 

12,600 

Total    

$13,200 

$13,200 

Bal    (Net  Capital) 

.  .     $12,600 

John  Smith 

$6  200 

Wm    Jones 

6  400 

$12,600 

$12,600 

The  balance  sheet  corresponding  to  the  ledger  accounts 
in  this  example  is  given  below.  It  is  constructed  in  the  same 
way  as  the  one  shown  in  Chapter  XV,  but  the  form  is  changed 
somewhat  in  order  to  make  a  clear  distinction  between  the 
accounts  of  original  entry  and  the  accounts  of  duplicate 
entry.  Of  course,  this  change  in  the  form  is  not  essential; 
it  is  given  merely  for  the  purpose  of  illustration. 


150 


PRINCIPLES    OF 


BALANCE  SHEET 


LEDGER  A 

iCCOUNTS 

INVK> 

TORY 

Net 
Debits 

Net 
Credits 

Debits 

(Lia- 
bilities) 

Credits 

(Assets) 

Debits 
(Losses) 

Credits 
(Gains) 

I 

II 

III 

IV 

V 

VI 

Cash  

$10,700 





$10,700 

Merchandise  

1,400 

2,500 

$1  100 

Bills  Payable  

$600 

$600 

Expense 

800 

$300 

•  .  •   • 

Bal. 
(Net 
Debit) 
11,800 

Bal. 

(Net 
Asset) 
12,600 

Bal. 

(Net 
Gain) 
800 

TOTALS  

$12,400 

$12,400 

$13,200 

$13,200 

$1,100 

$1,100 

Bal. 

(Net 
Debit) 
$11,800 

Bal. 

(Net 
Asset) 
$12,600 

Bal. 

(Net 
Gain) 
$800 

Smith  

$5800 

Net 
Asset 
$6  200 

Net 
Gain 
$400 

.... 

Jones..  . 

6  000 

Net 
Asset 
6400 

Net 
Gain 
400 

TOTALS  

$11,800 

$11,800 

$12,600 

$12,600 

$800 

$800 

In  closing  the  accounts  of  duplicate  entry  on  the  balance 
sheet  (as  in  the  ledger)  there  are  two  possible  methods  of 
procedure : 

1.  The  balance  of  $12,600  brought  down  in  Column  IV 
represents  the  net  asset  as  determined  by  inventory.  We 
divide  this  amount  between  Smith  and  Jones  in  Column  III. 
Since  Smith  has  drawn  out  $200,  his  portion  is  $200  less 
than  that  of  Jones;  therefore  we  assign  $6,200  to  the  one 
and  $6,400  to  the  other.  After  these  entries  have  been  made, 
the  excess  of  the  debit  in  Column  III  over  the  credit  in  Column 


DOUBLE-ENTKY   BOOKKEEPING  151 

II,  the  net  gain,  is  $400  in  each  case.  The  check  on  the 
correctness  of  the  work  lies  in  the  fact  that  after  the  two 
items  of  $400  each  have  been  entered  in  Column  V,  Columns 
V  and  VI  balance. 

2.  The  balance  of  $800  brought  down  in  Column  VI 
represents  the  net  gain  as  determined  by  the  accounts  of 
original  entry.  We  divide  this  amount  equally  between  Smith 
and  Jones  in  Column  V.  Adding  the  $400  in  Column  V  to 
the  $5,800  in  Column  II  we  determine  Smith's  net  asset 
($6,200),  and  adding  the  $400  in  Column  V  to  the  $6,000  in 
Column  II,  we  determine  Jones'  net  asset  ($6,400).  The 
check  on  the  correctness  of  the  work  lies  in  the  fact  that 
after  these  amounts  have  been  entered  in  Column  III, 
Columns  III  and  IV  balance. 

Theoretically,  the  first  method  is  the  proper  way  to  close 
the  accounts,  but  practically  it  is  always  done  according  to 
the  second  method;  that  is  to  say,  in  practice  the  bookkeeper 
always  closes  the  accounts  of  duplicate  entry  backwards. 

If  the  reader  will  turn  to  the  entries  given  in  the  above 
example,  he  will  observe  that  in  the  case  of  the  journal  entries 
which  record  transfers  of  losses  and  gains,  no  second  party 
is  indicated.  As  a  matter  of  fact,  these  entries  are  not  debits 
or  credits  'at  all,  and  therefore  there  is  no  second  party. 
In  merchandise  account,  for  example,  the  $1,100  is  not  a 
debit  to  Merchandise;  it  is  not  a  part  of  the  debit  side  of 
the  account,  it  is  the  excess  of  the  credit  side  over  the  debit 
side.  Nor  is  it  a  credit  to  Profit  and  Loss.  That  title  is  not 
the  heading  of  a  ledger  account,  it  is  not  the  name  of  an 
imaginary  person;  it  is  used  in  a  literal  sense,  and  therefore 
the  words  debtor  and  creditor  are  not  to  be  written  nor  are 
they  to  be  understood. 

In  closing  cash  account  it  is  perfectly  logical  to  say  that 
we  borrow  the  $10,700  from  the  imaginary  person  called 
Cash,  on  old  account,  and  lend  it  to  him  on  new  account; 


152  PRINCIPLES    OF 

therefore  he  is  creditor  to  us  on  the  old  account  and  debtor 
to  us  on  the  new  account.  But  in  the  case  of  expense  account 
it  would  be  an  absurdity  to  say  that  we  borrow  the  $300 
from  the  person  called  Expense  and  lend  it  to  the  person 
called  Profit  and  Loss,  because  the  only  reason  for  trans- 
ferring the  item  is  that  the  debt  is  bad,  and  if  the  debt  is 
bad  we  cannot  borrow  from  Expense.  To  say  that  we  borrow 
the  amount  from  the  person  called  Expense  is  equivalent  to 
saying  that  he  pays  the  debt.  It  follows,  therefore,  that  the 
entries  which  record  the  losses  and  gains  in  the  various 
accounts,  and  the  corresponding  entries  in  the  profit  and  loss 
statement,  are  not  to  be  regarded  as  debits  and  credits.  In 
order  to  bring  out  that  fact  clearly,  we  show,  in  the  ledger 
accounts  of  our  example,  the  totals  of  the  debits  and  credits, 
and  then  show  the  item  representing  loss  or  gain  as  the  excess 
of  the  one  side  over  the  other.  But  in  order  to  indicate 
that  in  this  example  the  accounts  of  duplicate  entry  are 
closed  backwards  (a  method  of  procedure  which  is  convenient 
in  practice  but  incorrect  in  theory)  we  show  each  partner's 
net  gain  as  a  credit  to  his  account,  and  then  show  his  net 
asset  as  the  excess  of  the  one  side  over  the  other. 

It  will  be  noted,  also,  that  the  entries  transferring  losses 
and  gains  can  be  omitted  from  the  journal  (and  in  practice 
they  always  are  omitted),  and  that  Profit  and  Loss  can  be 
omitted  from  the  ledger,  without  affecting  the  accounts  one 
way  or  the  other.  Bookkeepers  seem  to  think  that  Profit 
and  Loss  is  an  essential  part  of  the  ledger;  but  as  a  matter 
of  fact,  it  is  not  a  part  of  the  ledger  at  all.  It  is  not  a 
ledger  account;  it  is  simply  the  statement  of  losses  and  gains, 
which,  properly,  should  be  made  on  a  separate  sheet,  but  is 
carried  in  the  ledger  for  the  sake  of  convenience.  In  many 
cases  it  is  not  even  a  convenience;  it  is  carried  in  the  ledger 
merely  as  a  matter  of  custom. 

Sometimes  it  happens  that  the  bookkeeper  wishes  to  record 
a  loss  or  gain  during  the  period,  and  the  only  advantage  of 


DOUBLE-ENTRY    BOOKKEEPING  153 

carrying  Profit  and  Loss  in  the  ledger  is  that  it  enables  him 
to  do  so  without  throwing  his  books  out  of  balance ;  he  enters 
the  amount  of  the  loss  or  gain  on  the  proper  side  of  the 
account  in  question  and  on  the  opposite  side  of  the  profit 
and  loss  statement.  The  latter  entry  is  not  a  debit  or 
credit  to  Profit  and  Loss,  it  is  the  excess  debit  or  excess 
credit  of  the  account  in  which  the  loss  or  gain  has  occurred ; 
but  it  serves  to  keep  the  total  of  the  entries  on  the  left-hand 
side  equal  to  the  total  of  the  entries  on  the  right-hand  side. 

When  the  bookkeeper  does  not  record  any  losses  or  gains 
until  the  end  of  the  period  and  then  records  them  all  at  the 
same  time  (and,  theoretically,  that  is  what  he  is  supposed 
to  do),  there  is  no  advantage  whatever  in  making  the  state- 
ment of  losses  and  gains  in  the  ledger;  its  proper  place  is 
on  the  balance  sheet.  If  the  reader  will  turn  to  the  balance 
sheet  given  above,  he  will  observe  that  the  entries  in  Columns 
V  and  VI  are  exactly  the  same  as  the  entries  which  are 
made  in  the  ledger  under  the  heading  "Profit  and  Loss." 

Profit  and  Loss,  then,  is  not  a  ledger  account;  but  in 
practice  it  is  always  carried  in  the  ledger  in  the  same  form 
as  the  accounts,  and  therefore  it  is  commonly  called  an 
account.  The  bookkeeper  often  uses  this  so-called  account 
for  two  distinct  purposes.  When  he  records  transactions  in 
it,  he  is  using  it  as  a  current  account  of  original  entry,  of 
the  same  class  as  Interest  and  Expense  (as  if  the  title  were 
"Miscellaneous  Causes  of  Outgo  and  Income") ;  when  he 
transfers  losses  and  gains  to  it,  he  is  using  it  as  the  state- 
ment of  losses  and  gains. 

The  title  is  also  used  in  another  way.  In  railroad  account- 
ing (and  in  many  other  cases  also)  the  bookkeeper  closes 
Profit  and  Loss  by  balance  and  carries  the  balance  down  to 
new  account.  When  he  does  that,  he  is  carrying  Profit  and 
Loss  as  an  account  of  duplicate  entry;  it  is  exactly  equivalent 
to  the  account  which  is  commonly  called  Surplus  (or  Deficit). 
When  the  bookkeeper  carries  Profit  and  Loss  as  an  account  of 


154  PRINCIPLES    OF 

duplicate  entry,  he  usually  makes  his  statement  of  losses  and 
gains  under  the  heading  "Income/'  "Revenue,"  or  some 
similar  expression. 

If  accountants  had  any  regard  for  accuracy  in  nomencla- 
ture, they  would  have  one  heading  for  the  statement  of  losses 
and  gains,  another  for  the  account  of  original  entry  repre- 
senting miscellaneous  causes  of  outgo  and  income,  and 
another  for  the  account  of  duplicate  entry  representing 
surplus  or  deficit. 


DOUBLE-ENTRY   BOOKKEEPING  155 


CHAPTER    XVIII 

ACCOUNTS  OF  DUPLICATE  ENTRY  IN  PARTNERSHIP  ACCOUNTING 
AND   IN   CORPORATION   ACCOUNTING. 

In  the  case  of  a  firm,  according  to  current  practice,  each 
partner  always  has  a  proprietorship  account  and  usually  a 
personal  account  also.  His  proprietorship  account  is  between 
him,  as  a  member  of  the  firm,  and  the  outside  parties  col- 
lectively; his  personal  account  is  between  him,  as  an  outside 
party,  and  the  firm. 

Assuming,  for  example,  that  Thos.  Brown  is  a  member  of 
a  firm,  his  interest  amounting  to  $60,000,  and  that  he  has 
lent  $3,000  to  the  firm,  his  personal  account  is  in  this  form: 

Dr.  Thos.  Brown  Cr. 

To  Firm 

$2,000 


And  his  proprietorship  account  is  in  this  form: 

Dr.  Firm    (Thos.  Brown)  Cr. 

To  Outside  Parties 

$60,000 


If  a  partner's  personal  account  shows  a  credit,  it  means 
that  the  firm  owes  him  so  much  money;  the  account  is  on 
the  same  footing  as  any  other  personal  account,  except  that 
it  is  partially  self-contradictory.  But  in  the  case  of  the  credit 
which  appears  in  his  proprietorship  account,  it  is  not  the  firm 
that  owes  him  this  amount,  it  is  the  outside  parties  collectively. 

That  is  not  a  nominal  difference,  it  is  a  real  difference. 
If  a  firm  owes  one  of  its  members  a  certain  amount,  each  of 
the  other  partners  is  responsible  for  his  proportion  of  it; 


Ififi  PEINCIPLES    OF 

but  the  other  partners  have  no  responsibility  in  connection 
with  the  amount  which  is  owed  to  him  by  the  outside  parties 
collectively.  If  any  of  the  assets  prove  to  be  worthless,  he 
loses;  he  cannot  call  upon  the  other  partners  for  reim- 
bursement. 

Although  it  is  the  general  custom  to  carry  partnership 
accounts  with  the  members  of  a  firm,  in  many  cases  it  is 
entirely  unnecessary.  When  the  articles  of  agreement  specify 
the  interests  of  the  various  partners  as  certain  fractional 
parts  of  the  whole,  there  is  no  need  of  proprietorship 
accounts.  If  under  such  circumstances  proprietorship 
accounts  are  carried,  they  should  always  show  each  member's 
proportionate  interest  in  the  business;  it  is  clearly  an  incon- 
sistency when  the  articles  of  agreement  say  that  a  partner's 
interest  is  one  thing  and  the  ledger  says  that  it  is  something 
else. 

The  example  given  in  the  preceding  chapter  is  in  accord- 
ance with  the  practice  which  is  commonly  followed  in  such 
cases;  but  it  is  evident  that  the  result  is  inconsistent.  Smith 
and  Jones  are  supposed  to  be  equal  partners,  yet  at  the  end 
of  the  period,  according  to  the  ledger,  Smith's  interest  is 
worth  $6,200,  while  that  of  Jones  is  worth  $6,400.  In  other 
words,  although  they  are  supposed  to  have  equal  interests,  the 
ledger  shows  that  Smith's  interest  is  62/126  and  Jones' 
interest  is  64/126. 

In  the  example,  instead  of  saying  that  Smith  draws  out 
$200  for  personal  use,  it  would  be  more  in  accordance  with 
the  principles  of  correct  accounting  to  say  that  he  borrows 
$200  from  the  firm.  In  that  case,  to- record  the  transaction 
we  would  credit  Cash  and  debit  Smith's  personal  account, 
and  the  debit  would  represent  an  asset.  The  net  capital, 
then,  would  be  $12,800,  and  each  partner's  interest  would  be 
$6,400;  but,  of  course,  part  of  Smith's  share  would  be 
offset  by  the  debt  of  $200  which  he  owes  to  the  firm.  The 


DOUBLE-ENTKY   BOOKKEEPING  157 

result  would  be  the  same  as  before,  but  the  record  would  be 
more  correct  in  form. 

When  the  various  interests  are  fixed,  one  partner  should 
never  contribute  or  withdraw  anything  unless  the  others  do 
likewise,  each  in  proportion  to  his  interest;  net  capital  account 
(or  accounts  like  Contributed  Capital,  Surplus,  etc.)  should 
be  carried  in  place  of  the  partnership  accounts,  and  a  personal 
account  should  be  carried  with  each  member  of  the  firm. 
The  method  of  procedure,  then,  would  be  as  follows: 

To  declare  a  dividend: 

Debit  net  capital  account  (or  Surplus)  with  the  total 
amount  of  the  dividend  and  credit  each  partner's  personal 
account  with  his  proportion  of  it. 

When  any  partner  receives  his  dividend,  debit  his  personal 
account  and  credit  Cash. 

To  levy  an  assessment: 

Credit  net  capital  account  (or  Contributed  Capital)  with 
the  total  amount  of  the  assessment  and  debit  each  partner's 
personal  account  with  his  proportion  of  it. 

When  any  partner  pays  his  assessment,  credit  his  personal 
account  and  debit  Cash. 

But  in  many  cases  the  articles  of  agreement  specify  that 
each  partner's  interest,  instead  of  being  a  fixed  part  of  the 
whole,  shall  be  in  proportion  to  his  investment  in  the  business. 
Under  such  circumstances  it  is,  of  course,  necessary  to  carry 
partnership  accounts  as  well  as  personal  accounts,  in  order 
to  distinguish  between  the  contributions  and  withdrawals 
made  by  each  partner  and  the  amounts  which  he  may  lend 
to,  or  borrow  from,  the  firm.  The  amount  of  his  interest 
depends  upon  the  contributions  and  withdrawals;  it  is  not 
affected  by  the  loans. 

Theoretically,  as  explained  in  Chapter  VIII,  there  is  no 
reason  why  the  books  of  an  individual  proprietor  or  of  a 


158 


PEINCIPLES    OF 


firm  (wlieu  the  interests  are  fixed)  shouid  not  be  kept  in  the 
same  form  as  those  of  a  corporation.  But  in  practice  the 
bookkeeper  always  carries  net  capital  account  when  the  pro- 
prietor is  an  individual,  partnership  accounts  when  the 
proprietor  is  a  firm,  and  accounts  like  Capital  Stock  and 
Surplus  when  the  proprietor  is  a  company. 

In  the  first  two  cases  the  purpose  of  the  accounts  of 
duplicate  entry  is  evident,  their  object  being  to  show  the  net 
capital  of  the  single  proprietor  in  the  one  case,  and  of  the 
various  partners  in  the  other  case.  In  these  two  cases,  then, 
the  subject  presents  no  difficulties;  but  in  the  books  of 
corporations  accounts  of  duplicate  entry  are  used  in  great 
variety,  and  it  is  in  this  form  of  accounting  that  they  need 
explanation,  since  the  bookkeeper  has  never  had  any  but  the 
vaguest  ideas  as  to  their  meaning. 

In  corporation  accounting  the  account  under  the  head  of 
Capital  Stock  represents  the  capital  contributed  by  the  share- 
holders, and  therefore  under  normal  conditions  the  net 
capital  equals  the  capital  stock  at  the  beginning  and  exceeds 
it  at  any  subsequent  date.  But  under  adverse  conditions  the 
net  capital  at  a  subsequent  date  may  be  less  than  the  capital 
stock  (in  which  case  the  capital  is  said  to  be  impaired),  or 
the  net  capital  may  be  negative,  that  is  to  say,  the  liabilities 
may  exceed  the  assets  (in  which  case,  the  company,  according 
to  the  books,  is  insolvent).  There  are,  then,  four  possible 
cases,  as  illustrated  by  the  following  examples: 

1.     The  net  capital  equals  the  capital  stock. 


ASSETS 

LIABILITIES 

Cash 

$100  000 

None. 

Bal.   (Net 

Capital)    .. 

$100,000 

Total     

$100,000 

$100,000 

Bal.   (Net  Capital)    .  . 

$100,000 

Capital  S 

tock   

$100,000 

$100,000 

$100,000 

DOUBLE-ENTKY    BOOKKEEPING 
2.     The  net  capital  exceeds  the  capital  stock. 


159 


ASSETS 

LIABILITIES 

Total    

$40,000 
120,000 

Bal.   (Net  Capital)    .  . 

Total    

.  .  $160,000 

$160,000 

Bal.   (Net  Capital) 

..  $120,000 

Capital  Stock   

$100,000 
20,000 

$120,000 

$120,000 

3.     The  net  capital  is  less  than  the  capital  stock, 
assets  exceed  the  liabilities. 

but  the 

ASSETS 

LIABILITIES 

Total    

$40,000 
90,000 

Bal.   (Net  Capital)    .. 

Total    

.  .  .  $130  000 

$130,000 

Bal.   (Net  Capital) 
Deficit    

.  .     $90,000 
10,000 

Capital  Stock   

$100,000 

$100,000 

$100,000 

4.     The  net  capital  is  negative,  that  is  to  say, 
bilities  exceed  the  assets. 

the  lia- 

ASSETS 

LIABILITIES 

Total 



$50  000 

Bal.    (Net  Capital) 

30,000 

$80,000 

Total 

$80,000 

Deficit   

...  $130,000 

Bal.   (.Net  Capital)    .. 
Capital  Stock   .  . 

$30,000 
100,000 

$130,000 

I 

$130,000 

160  PRINCIPLES    OF 

It  will  be  noted  that  double-entry  bookkeeping  does  not 
use  the  signs  "+"  and  " — ",  but  the  position  of  the  entry 
on  the  statement  indicates  whether  the  net  capital  is  positive 
or  negative. 

The  truth  of  the  remark  that  the  bookkeeper  has  only  the 
vaguest  ideas  as  to  the  meaning  of  accounts  of  duplicate  entry 
is  evident  from  the  fact  that  when  the  balances  of  such 
accounts  are  brought  down  as  debits  he  classifies  them  as 
assets,  and  when  they  are  brought  down  as  credits  he  classi- 
fies them  as  liabilities,  which  is  an  utter  absurdity.  The 
balances  of  accounts  of  duplicate  entry  do  not  represent  assets 
and  liabilities  (assets  and  liabilities  are  not  to  be  counted 
twice);  they  do  not  represent  concrete  things  at  all;  they 
represent  portions  of  the  net  capital  regarded  as  an  abstract 
quantity. 

The  reader  will  find  it  easy  to  understand  these  accounts, 
as  used  in  corporation  accounting,  if  he  will  keep  in  mind 
the  fact  that  their  only  value  is  in  their  bearing  upon  the 
matter  of  dividends  (or  assessments).  When  the  books  of 
a  corporation  are  closed  at  the  end  of  a  period,  the  first 
question  which  arises  is:  What  dividends  can  be  declared — 
if  any  ?  The  object  of  the  subdivisions  of  net  capital  account 
is  to  facilitate  the  discussion  of  that  question;  they  serve 
no  other  purpose  whatsoever.  Dividends  are  to  be  paid  only 
out  of  profits,  they  are  not  to  be  paid  out  of  the  contributed 
capital;  therefore  there  can  be  no  dividends  unless  the  net 
capital  exceeds  the  capital  stock.  But  even  when  that  is  the 
case,  it  does  not  follow  that  all  of  the  excess  can  be  dis- 
tributed ;  as  a  rule,  certain  portions  of  it  must  be  reserved  for 
various  reasons. 

For  illustration  we  will  suppose  that  the  total  of  the 
assets  is  $6,000,000  and  the  total  of  the  liabilities  $2,000,000. 
The  net  capital,  then,  is  $4,000,000,  and  assuming  the  capital 
stock  to  be  $3,000,000,  the  surplus,  that  is  to  say,  the 
remainder  of  the  net  capital,  is  $1,000,000.  But  we  will 


DOUBLE-ENTKY    BOOKKEEPING 


161 


assume  that  this  surplus  is  not  all  available  for  dividends; 
certain  portions  of  it  must  be  reserved,  for  the  following 
reasons : 

1.  We  have  issued  bonds,  and  having  invested  the  pro- 
ceeds in  permanent  improvements  must  accumulate  profits 
in  order  to  be  prepared  to  pay  off  the  bonds  when  they 
become    due.      The    accumulation    should    now    amount    to 
$400,000,  therefore  that  amount  must  be  reserved. 

2.  We  are  carrying  our  own  insurance  and  are  accumu- 
lating profits  to  meet  possible  fire  losses.    The  accumulation 
should  now  amount  to  $140,000,  therefore  that  amount  must 
be  reserved. 

3.  We  have  planned  to  make  an  addition  to  the  plant 
at  a  cost  of  $150,000,  therefore  that  amount  must  be  reserved 
for  extensions. 

4.  Our  experience  has  shown  that  of  the  accounts  receiv- 
able which  we  suppose  to  be  good,  a  certain  percentage  gen- 
erally proves  to  be  bad.     To  provide  for  this  probable  loss, 
we  must  reserve  $10,000  for  bad  debts. 

After  deducting  these  amounts  from  the  $1,000,000,  the 
surplus,  that  is  to  say,  the  remainder  of  the  net  capital,  is 
$300,000.  The  bookkeeping  way  to  make  the  deductions  is 
simply  to  debit  Surplus  and  credit  the  accounts  mentioned 
above.  Our  statement,  then,  is  as  follows: 


ASSETS 

LIABILITIES 

Total  

$2  000  000 

Bal.    (Net  Capital)  .. 

4,000,000 

Total         $6,000000 

$fi  noft  flnfi 

Bal.  (Net  Capital)...  $4,000,000 

Capital   Stock    

$3  000  000 

Sinking  Fund    .... 

400  000 

Insurance  Reserve  .  . 
ResVd  for  Extensions 
Res'v'd  for  Bad  Debts 
Surplus    

.     140,000 
150,000 
10,000 
300,000 

$4,000,000 

$4,000,000 

162 


PKINCIPLES    OF 


In  this  statement  we  have  not  answered  the  question  as 
to  what  dividends  can  be  declared,  but  we  have  narrowed  it 
down.  We  have  not  indicated  what  can  be  distributed,  but 
we  have  indicated  certain  amounts  which  are  not  to  be  dis- 
tributed. The  question  now  is,  not  what  part  of  this 
$1,000,000  can  be  distributed,  but  what  part  of  this  $300,000 
is  it  advisable  to  distribute  in  dividends. 

If,  now,  we  decide  to  declare  a  dividend  of  6  per  cent  on 
the  contributed  capital,  we  debit  Surplus  and  credit  Dividend 
and  carry  the  item  as  a  liability.  The  statement  then  takes 
this  form: 


ASSETS 

LIABILITIES 

Miscellaneous                $6  000  000 

Miscellaneous                $2  000  000 

Dividend                             180  000 

Total                            $2  180  000 

Bal.  (Net  Capital)...  3,820,000 

Total  $6,000,000 

$6,000,000 

Dal    (Net  Capital)  ..  .$3  820  000 

Capital  Stock  $3,000,000 

Sinking  Fund  400,000 

Insurance  Reserve  .  .      140,000 
Res'v'd  for  Extensions      150,000 
Res'v'd  for  Bad  Debts        10,000 
Surplus  120,000 

$3,820,000 

$3,820,000 

As  illustrated  by  this  example,  the  subdivisions  of  net 
capital  account  which  are  used  in  the  books  of  corporations 
consist  of  reserve  accounts  and  a  residual  account.  That 
is  to  say,  they  consist  of  accounts  showing  the  amounts  which 
for  various  reasons  are  to  be  regarded  as  set  aside  or  reserved, 
and  an  acc'ount  showing  the  remainder  of  the  net  capital  after 
these  amounts  have  been  deducted.  Capital  Stock  shows  the 
amount  which  is  to  be  reserved  as  representing  the  con- 
tributed capital,  and  the  other  reserve  accounts  show  the 


DOUBLE-ENTRY   BOOKKEEPING  163 

amounts  which  are  supposed  to  be  set  aside  for  reasons  which 
are  more  or  less  clearly  indicated  by  the  titles. 

"Surplus"  is  the  term  which  is  commonly  used  to  desig- 
nate the  residual  account;  but  banks  use  that  term  as  the 
title  of  a  reserve  account,  and  use  the  expression  "Undivided 
Profits"  to  designate  the  residual  account;  while  railroad 
accountants  use  the  term  "Profit  and  Loss"  as  the  title  of 
the  residual  account,  and  make  their  statement  of  losses  and 
gains  under  the  heading  "Income,"  "Revenue,"  or  some 
similar  expression.  All  of  which  goes  to  show  that  the 
nomenclature  of  accounting  is  sadly  in  need  of  revision. 


164  PRINCIPLES    OF 


CHAPTER   XIX 

DEBTS  AND  OBLIGATIONS — CONTINGENT  LIABILITIES — ANALOGY 
BETWEEN  THE  LANGUAGE  OF  DOUBLE-ENTRY  BOOKKEEPING 
AND  ORDINARY  LANGUAGE. 

In  discussing  the  subject  of  bookkeeping  it  is  necessary 
to  distinguish  clearly  between  the  words  debt  and  obligation; 
a  debt  is  always  an  obligation,  but  an  obligation  is  not  neces- 
sarily a  debt.  Only  an  obligation  in  the  form  of  a  debt  can 
be  an  asset  or  a  liability,  and,  therefore,  while  we  are  bound 
to  record  every  debt  in  the  ledger,  we  are  not  bound  to 
record  every  obligation. 

For  example,  if  a  company  issues  5  per  cent  bonds  to  the 
amount  of  $100,000  payable  in  ten  years,  it  assumes  two 
obligations,  one  to  pay  $100,000  principal  and  the  other  to 
pay  $50,000  interest.  One  of  these  obligations  is  a  debt, 
that  is  to  say,  it  is  a  liability;  the  other  is  not.  The  book- 
keeper does  not  make  any  record  of  the  interest,  except  as  it 
accrues. 

Every  contract  or  agreement  involves  an  idea  both  of 
asset  and  of  liability;  the  above  example  involves  two  ideas 
of  asset  and  two  of  liability.  In  the  case  of  the  principal, 
the  asset  is  the  money  received  for  the  bonds,  the  liability 
is  the  obligation  to  redeem  them;  in  this  case  both  the  asset 
and  the  liability  have  accrued.  In  the  case  of  the  interest, 
the  asset  is  the  right  to  use  the  principal  for  ten  years,  the 


DOUBLE-ENTRY    BOOKKEEPING  165 

liability  is  the  obligation  to  pay  the  interest;  in  this  case 
neither  the  asset  nor  the  liability  has  accrued. 

As  another  illustration,  exactly  analogous  to  the  case  of 
the  interest  on  the  bonds,  we  will  assume  that  a  certain 
company  leases  a  building  for  ten  years  at  an  annual  rental 
of  $5,000;  in  other  words,  it  agrees  to  pay  $50,000  in  the 
course  of  ten  years.  In  this  case  the  asset  is  the  right  to 
use  the  building  for  ten  years,  the  liability  is  the  obligation 
to  pay  the  rent;  but  as  yet  neither  the  asset  nor  the  liability 
has  accrued. 

It  is  not  customary  to  record  such  items  in  the  books 
at  all  (except  as  the  debt  accrues),  but  if  it  were  thought 
worth  while,  it  could  be  done  by  using  two  accounts,  one  to 
show  the  item  as  an  asset  and  the  other  to  show  it  as  a 
liability.  If  the  item  increases,  we  debit  the  asset  account 
and  credit  the  liability  account;  if  the  item  decreases,  we 
credit  the  asset  account  and  debit  the  liability  account. 

In  the  case  of  the  lease  mentioned  above,  the  first  entry 
would  be  as  follows : 

Dr.  Cr. 

Lease  of  Building   (Asset)    $50,000 

Lease  of  Building  (Liability)    $50,000 

Since  the  amount  involved  in  the  lease  decreases  by  $5,000 
annually,  the  entry  at  the  end  of  each  year  would  be  in 
this  form : 

Dr.  Cr. 

Lease  of  Building   (Liability)    $5,000 

Lease  of  Building  (Asset)    $5,000 


At  the  expiration  of  the  lease,  the  accounts  would  appear 
in  the  ledger  as  follows : 


166                            PRINCIPLES    OF 
Dr.                            Lease  of  Building   (Asset) 

Cr. 

Jan.  1,  1901  $50,000 

Dec.  31,  1901  

$5,000 

Dec    31    1902 

5  000 

Dec.  31,  1903  

5,000 

Dec   31    1904 

5  000 

Dec    31    1905 

5  000 

Dec    31    1906 

5  000 

Dec    31    1907 

5  000 

Dec    31    1908 

5  000 

Dec    31    1909 

5  000 

Dec    31    1910 

5  000 

$50,000 

$50,000 

Dr. 


Lease  of  Building   (Liability) 


Cr. 


Jan  1  1901  .  .    $50,000 

Dec.  31,  1901 

$5  000 

Dec  31  1902  

5,000 

Dec.  31  1903  ... 

5,000 

Dec.  31,  1904  

5,000 

Dec.  31,  1905  

5,000 

Dec.  31,  1906  

5,000 

Dec.  31,  1907  

5,000 

Dec  31  1908 

5  000 

Dec  31  1909 

5  000 

Dec  31  1910 

5  000 

. 

$50,000 

$50,000 

By  using  two  accounts  any  obligation,  or,  for  that  matter, 
any  item  which  is  neither  an  asset  nor  a  liability,  can  be 
entered  in  the  books.  Recording  an  item  in  that  way  simply 
makes  a  memorandum  of  it  and  does  not  affect  the  accounts 
one  way  or  the  other. 

When  a  person  promises  to  do  a  certain  thing,  he  assumes 
a  positive  obligation;  when  he  promises  to  do  a  certain  thing 
in  case  certain  circumstances  arise,  he  assumes  a  conditional 
obligation.  In  bookkeeping,  the  conditional  obligations  which 
the  proprietor  assumes  are  commonly  called  "contingent 
liabilities." 


DOUBLE-ENTKY   BOOKKEEPING  167 

For  illustration  we  may  take  the  case  of  a  fire-insurance 
company.  The  company  has  policies  outstanding  to  a  certain 
amount  and  the  premiums  on  the  policies  have  been  paid. 
Now,  in  the  proper  sense  of  the  word,  the  only  liability  of  the 
company  in  connection  with  these  policies  is  the  amount  of 
the  prepaid  premiums;  meaning,  of  course,  not  the  original 
amount  prepaid,  but  the  amount  which  stands  as  prepaid 
now.  This  amount  is  a  debt,  since  the  company  has  received 
the  money  from  the  policyholders  and,  as  yet,  has  given 
nothing  in  return.  The  company's  contingent  liability,  how- 
ever, is  limited  only  by  the  total  amount  of  the  policies,  with 
the  probability  that  the  loss  will  bear  about  the  same  ratio 
to  the  whole  amount  as  in  previous  years.  But  the  contin- 
gent liability  is  not  a  debt  and  therefore  it  is  not  a  liability, 
since  the  word  liability,  when  used  alone,  means  an  accrued 
liability,  and  in  the  case  of  insurance  against  loss  by  fire 
the  liability  does  not  accrue  until  the  loss  occurs. 

All  cases  in  which  an  asset  or  a  liability  may  accrue  under 
certain  conditions,  represent  contingent  assets  and  liabilities. 
A  contingent  asset  may  be  recorded  in  the  ledger  both  as  an 
asset  and  as  a  liability,  thus  making  a  memorandum  of  it 
without  affecting  the  accounts;  but  it  is  customary  not  to 
record  contingent  assets  at  all,  while  contingent  liabilities 
are  recorded  by  means  of  accounts  of  duplicate  entry. 

In  the  case  of  the  fire-insurance  company,  for  example, 
the  amount  of  the  prepaid  premiums  should  appear  as  a 
liability,  while  the  estimated  excess  of  the  contingent  lia- 
bility (that  is  to  say,  the  estimated  amount  by  which  the 
losses  may,  perhaps,  exceed  the  premiums)  should  appear  as 
a  portion  of  the  net  capital  reserved  to  meet  the  liability 
when  it  accrues  or  if  it  accrues.  Under  normal  conditions 
the  amount  of  the  prepaid  premiums  is  more  than  enough 
to  cover  the  losses ;  in  other  words,  the  increase  of  net  capital 
due  to  the  gradual  extinction  of  liability  under  the  head  of 
Prepaid  Premiums  is  greater  than  the  decrease  due  to  loss 


168 


PRINCIPLES    OF 


by  fire.  But  to  provide  for  the  possibility  of  extraordinary 
losses,  a  reserve  account  is  carried  to  indicate  that  a  certain 
portion  of  the  net  capital  is  not  to  be  distributed  in  dividends. 

It  is  not  always  easy  to  determine  whether  a  liability  has 
really  accrued  or  not,  and  therefore  it  is  sometimes  a  ques- 
tion whether  to  record  an  item  as  a  present  liability  or  as 
a  portion  of  the  net  capital  reserved  to  meet  a  future  lia- 
bility. If,  for  example,  a  bank  pays  interest  on  time  deposits 
with  the  understanding  that  if  the  money  is  drawn  out  before 
the  time  expires  the  interest  is  forfeited,  then  the  liability 
of  the  bank  on  account  of  the  interest  is,  to  a  certain  extent, 
contingent.  Therefore  the  item  representing  the  amount  of 
such  interest  which  has  accrued  to  date  may  be  entered  in 
either  of  two  ways. 

For  illustration,  we  will  assume  that  the  item  amounts 
to  $5,000,  and  that  before  it  is  taken  into  consideration  at 
all,  the  statement  of  the  bank  is  as  follows: 


ASSETS 

LIABILITIES 

Total 

$1  030  000 

Bal.  (Net  Capital).. 

170,000 

Total  $1,200  000 

$1,200,000 

Bal    (Net  Capital)     .    $170,000 

Capital    Stock      .... 

$100,000 

Surplus    

50,000 

Undivided   Profits    . 

20,000 

$170,000 

$170,000 

If  we  regard  the  liability  on  account  of  the  interest  as 
an  accrued  liability,  the  entry  will  be  in  this  form: 


DOUBLE-ENTRY   BOOKKEEPING  169 


Dr.  (Jr. 

Profit  and  Loss    '. $5,000 

Accrued  Interest  Payable   $5,000 

The  debit  to  Profit  and  Loss  is  transferred  to  Undivided 
Profits,  and  then  the  statement  takes  this  form : 

ASSETS  LIABILITIES 

Miscellaneous     $1,030,000 

Accrued  Int.  Pay.  ...         5,000 

Total    $1,035,000 

Bal.    (Net  Capital)..      165,000 

Total    $1,200,000  $1,200,000 

Bal.  (Net  Capital)..  $165,000  Capital  Stock  $100,000 

Surplus  50,000 

Undivided  Profits  ..  15,000 

$165,000 $165,000 

If,  on  the  other  hand,  we  regard  the  item  as  a  contingent 
liability,  the  entry  will  be  in  this  form : 

Dr.  Cr. 

Undivided  Profits    $5,000 

Reserved  for  Interest    $5,000 

And  the  statement  will  be  as  follows : 

ASSETS  LIABILITIES 

Total    $1,030,000 

Bal.  (Net  Capital)...      170,000 

Total    $1,200,000  $1,200,000 

Bal.  (Net  Capital) ...    $170,000      Capital   Stock    $100,000 

Surplus    50,000 

Reserved  for   Int.    ..  5,000 

Undivided    Profits    ..  15,000 

$170,000  $170,000 


170  PRINCIPLES    OF 

It  will  be  noted  that  in  the  first  case  we  debit  Profit 
and  Loss  and  credit  Accrued  Interest  Payable,  and  carry  the 
item  as  a  liability,  while  in  the  second  case  we  debit  Undi- 
vided Profits  and  credit  Reserved  for  Interest.  To  debit 
Profit  and  Loss  and  credit  Reserved  for  Interest  would  be 
an  absurdity;  an  item  which  has  been  charged  out  as  a  loss 
does  not  represent  a  reserve,  it  represents  a  liability.  The 
accruing  of  a  liability  is  loss.  Therefore,  if  we  wish  to 
indicate  that  the  loss  has  occurred,  we  must  represent  the 
liability  as  accrued;  but  if  we  wish  to  indicate,  not  that  the 
loss  has  occurred,  but  that  it  is  likely  to  occur  in  the  future, 
we  must  represent  a  portion  of  the  net  capital  as  reserved  to 
meet  the  liability  when  it  accrues  or  if  it  accrues. 

The  reader  should  keep  in  mind  the  fact  that  double- 
entry  bookkeeping  is  a  language — a  mode  of  expression — and 
should  not  overlook  the  analogy  which  it  bears  to  ordinary 
language.  In  the  ledger  account  a  debit  entry  means  that 
the  first  party  owes  the  second  party,  it  corresponds  to  the 
active  form  of  the  verb;  a  credit  entry  means  that  the  first 
party  is  owed  by  the  second  party,  it  corresponds  to  the 
passive  form. 

In  the  example  given  above,  the  difference  between  the 
two  cases  is  the  difference  between  the  indicative  or  positive 
form  of  the  verb  and  the  subjunctive  or  conditional  form. 
In  the  one  case  we  say  that  the  loss  of  $5,000  due  to  the 
accruing  of  interest  payable  has  occurred;  in  the  other  case 
we  say  that  it  may  occur  or  is  likely  to  occur.  In  the  one 
case  we  make  the  positive  statement  that  the  net  capital  of 
the  bank  is  $165,000.  In  the  other  case  we  make  a  modified 
statement;  we  say  that  the  net  capital  is  $170,000,  but 
$5,000  is  reserved  to  meet  a  liability  which  is  expected  to 
accrue  in  the  future. 


DOUBLE-ENTRY   BOOKKEEPING  171 

CHAPTER   XX 

TO  OPEN  THE  BOOKS  OF  A  CORPORATION — TREASURY  STOCK. 

To  form  a  company  the  incorporates  decide  upon  the 
amount  of  the  capital  stock  and  then  each  of  them  subscribes 
for  a  certain  portion  of  it.  If  the  capital  stock  is  $100,000 
and  it  is  all  subscribed,  the  entry  to  open  the  books  is  as 
follows : 

Dr.  Cr. 

Subscription    $100,000 

Capital  Stock   $100,000 

Here  the  amount  under  the  head  of  Subscription  repre- 
sents asset,  because  the  subscribers  have  promised  to  con- 
tribute the  amount  and  the  law  recognizes  the  obligation; 
while  the  amount  under  the  head  of  Capital  Stock  represents 
the  net  capital.  Assuming  that  all  the  payments  are  made 
in  cash,  then  as  each  payment  is  made  we  debit  Cash  and 
credit  Subscription.  After  all  the  payments  have  been  made, 
subscription  account  balances  and  the  statement  becomes: 

Dr.  Cr. 

Cash    $100,000 

Capital  Stock   $100,000 

The  above  are  the  entries  which  are  made  in  the  journal 
and  are  posted  to  the  ledger.  The  records  showing  the  names 
of  the  incorporates,  the  amount  for  which  each  of  them 
subscribes,  the  payments  which  he  makes,  etc.,  etc.,  are,  of 
course,  kept  in  auxiliary  books. 

But  sometimes  the  incorporators  do  not  subscribe  for  all 
of  the  stock ;  they  subscribe  for  only  a  portion  of  it,  and  then 
the  remainder  (called  treasury  stock)  is  held  in  common. 


172  PRINCIPLES    OF 

The  advantage  of  this  method  of  procedure  is  that  if  at  any 
time  the  stockholders  find  that  they  need  more  capital  in 
order  to  enlarge  the  business,  they  can  sell  the  treasury  stock, 
or  such  portion  of  it  as  may  be  necessary,  without  further 
formality. 

In  some  cases  the  law  does  not  permit  the  incorporation 
of  a  company  unless  all  of  the  stock  is  subscribed,  and  in 
some  cases,  also,  it  makes  a  distinction  between  stock  which 
has  never  been  issued  and  stock  which  has  been  issued  and 
subsequently  re-acquired.  But  the  laws  of  different  states 
and  countries  vary,  while  the  principles  of  double-entry  book- 
keeping are  the  same  everywhere,  and  therefore  we  will  dis- 
cuss the  subject  purely  from  the  accounting  standpoint,  regard- 
less of  the  legal  aspect  of  the  case. 

We  will  assume,  then,  that  the  capital  stock  is  $100,000 
and  that  the  subscriptions  amount  to  $60,000,  leaving  stock 
of  a  nominal  value  of  $40,000  unissued.  The  entry  to  open 
the  books  is  as  follows: 

Dr.  Cr. 

Subscription    $60,000 

Treasury   Stock    40,000 

Capital  Stock   $100,000 

According  to  current  practice  the  bookkeeper  makes  no 
distinction  between  liability  and  net  asset  nor  between  asset 
and  net  liability.  He  says  that  the  amount  under  the  head 
of  Capital  Stock  is  a  liability  and  that  the  amount  under 
the  head  of  Treasury  Stock  is  an  asset — which  is  an  absurdity. 
The  amount  under  the  head  of  Subscription  is  an  asset, 
because  the  incorporators  have  promised  to  contribute  it; 
it  is  an  account  receivable.  But  no  one  has  promised  to  con- 
tribute the  amount  under  the  head  of  Treasury  Stock,  and 
therefore  it  is  not  an  asset. 

Subscription  is  an  account  of  original  entry,  while 
Treasury  Stock  and  Capital  Stock  are  accounts  of  duplicate 


DOUBLE-ENTBY   BOOKKEEPING 


173 


entry.     If  the  titles  were  written  in  full,  the  entries  to  open 
the  books  would  be  in  this  form : 


JOURNAL 


Dr. 


Cr. 


Company 
Parties 
Company 

Dr. 

(Treasury     Stock),     to     Outside 
40,000 

$100,000 
Cr. 

(Capital  Stock),  to  Outside  Parties 

LEDGER 
Subscription 
To  Company 

$60,000 

Dr. 

Company  (Treasury  Stock) 
To  Outside  Parties 

Cr. 

$40,000 

Dr. 

Company   (Capital  Stock) 
To  Outside  Parties 

Cr. 

$100,000 

The  statement  corresponding  to  the  above  ledger  accounts 
would  be  in  this  form : 


ASSETS 

LIABILITIES 

Subscription          .    . 

.  .  .  $60,000 

None. 

Bal.   (Net  Capital)    . 

..  $60,000 

Total    

.  .  .  $60,000 

$60,000 

Bal     (Net   Capital) 

.  .   $60,000 

Capital  Stock  

.  .$100,000 

Treasury  Stock  

40,000 

$100,000 

$100,000 

174 


PRINCIPLES    OF 


In  this  statement  the  net  capital  is  indicated  as  composed 
of  two  items,  positive  net  capital  to  the  amount  of  $100,000 
and  negative  net  capital  to  the  amount  of  $40,000.  That  is 
simply  another  way  of  saying  that  we  enter  the  total  amount 
of  the  capital  stock  as  representing  net  asset,  and  then  enter 
the  amount  of  the  treasury  stock  as  an  offset  to  that  part  of 
the  capital  stock  which  was  not  subscribed.  The  idea  may 
also  be  expressed  in  this  way:  To  say  that  the  net  capital 
(net  asset)  is  $60,000  means  that  the  outside  parties  col- 
lectively owe  the  company  that  amount.  Now  to  say  that 
the  outside  parties  owe  the  company  $60,000  is  equivalent 
to  saying  that  the  outside  parties  owe  the  company  $100,000 
and  the  company  owes  the  outside  parties  $40,000. 

We  will  now  assume  that  the  company  has  been  in  business 
for  some  time,  but  none  of  the  treasury  stock  has  been  issued. 
Its  statement  is  as  follows: 


ASSETS 

LIABILITIES 

Total     

$20  000 

Bal.   (Net  Capital)    . 

.  .     70,000 

Total           

.     $90,000 

$90  000 

Bal.   (Net  Capital) 

.  .  .   $70,000 

Capital  Stock  

.  .$100,000 

Treasury  Stock  .  .  . 

.  .     40,000 

Surplus 

10  000 

$110,000 

$110,000 

This  statement  means  simply  that  the  stockholders  con- 
tributed $60,000  and  their  net  capital  is  now  $70,000,  there- 
fore they  have  a  surplus  of  $10,000. 

According  to  the  current  method  of  making  such  state- 
ments the  bookkeeper,  if  he  shows  treasury  stock  at  all,  shows 
it  as  an  asset,  and  that  is  so  misleading  that  in  some  cases  the 
law  has  thought  it  necessary  to  forbid  the  practice  altogether. 


DOUBLE-ENTKY   BOOKKEEPING  175 

But  as  illustrated  by  the  above  example,  when  the  report  is 
made  in  proper  form  there  is  nothing  misleading  about  it, 
since  the  amount  of  the  net  capital  is  distinctly  stated,  and 
it  is  evident  at  a  glance  that  the  method  of  determining  the 
net  capital  is  entirely  independent  both  of  the  capital  stock 
and  of  the  treasury  stock. 


176  PRINCIPLES    OF 


CHAPTER    XXI 

DEPRECIATION — RESERVES   TO   MEET   FIRE   LOSSES — A   COMMON 

ERROR  IN  THE  TREATMENT  OF  SUCH  ACCOUNTS GENERAL 

TEST  TO   WHICH  EVERY  SET  OF  BOOKS  SHOULD  CONFORM. 

The  term  depreciation  means  the  decrease  in  value  which 
in  most  things  inevitably  occurs  with  the  lapse  of  time.  The 
plant  of  a  manufacturing  establishment,  for  example,  gradu- 
ally becomes  less  efficient,  in  spite  of  the  repairs  which  are 
made  as  occasion  demands  to  keep  it  in  running  order. 
Machinery  finally  becomes  so  worn  out  or  so  old-fashioned 
that  it  no  longer  pays  to  operate  it,  and  it  must  be  replaced. 
Depreciation,  then,  is  an  expense  and  sooner  or  later  it  must 
be  charged  out  as  a  loss. 

If  we  credit  the  plant  account  at  the  end  of  the  period 
with  the  estimated  value  of  the  plant  at  that  time  and  carry 
it  down  to  new  account  as  a  debit,  then,  of  course,  the  loss 
by  depreciation  appears  in  that  account.  But  it  is  desirable 
that  the  account  should  show  the  original  cost  of  the  plant 
rather  than  its  present  value,  and  there  are  two  other  ways 
in  which  the  record  of  depreciation  may  be  kept : 

1.  At  the  end  of  each  period  we  debit  Expense  with 
the  estimated  amount  of  the  depreciation  and  credit  Depre- 
ciation of  Plant  and  carry  the  item  as  a  liability. 

2.  At  the  end  of  each  period  we  debit  Surplus  and  credit 
Depreciation  Reserve,  and  carry  the  item  as  a  portion  of  the 
net  capital  reserved  to  meet  the  loss  when  it  occurs. 

In  the  first  case  we  recognize  the  fact  that  the  loss  has 
already  occurred.  In  the  second  case  we  are  postponing  the 
recognition  of  the  loss  until  it  becomes  necessary  to  replace 
all  or  part  of  the  plant. 

But  loss  by  depreciation  is  inevitable,  and  one  of  the 
principal  purposes  of  accounting  is  to  assign  all  losses  and 
gains  to  the  proper  causes  and  to  the  proper  periods.  There- 


DOUBLE-ENTRY    BOOKKEEPING 


177 


fore,  as  between  the  two  methods  given  above,  it  is  more 
logical  to  charge  out  the  estimated  amount  of  the  deprecia- 
tion as  a  loss  at  the  end  of  each  period,  because,  even  though 
the  estimate  be  very  far  from  the  truth,  we  come  nearer  to 
an  equitable  distribution  than  we  would  by  throwing  the 
whole  loss  upon  the  last  period. 

For  illustration,  we  will  assume  that  at  the  end  of  each 
period  we  make  this  entry: 

Dr.  Cr. 


Expense    $5,000 

Depreciation  of  Plant   


And  that  the  statement  is  now  as  follows : 


$5,000 


ASSETS 

LIABILITIES 

Miscellaneous    

.$115,000 

Miscellaneous 

$50  000 

Plant     .  . 

100  000 

Depreciation  of  Plant 

30  000 

Cash     

.     15,000 

Total    

.   $80,000 

Bal.   (Net  Capital)... 

.   150,000 

Total    

.$230  000 

$230  000 

Bal.   (Net  Capital)... 

.$150,000 

Capital  Stock   

.$100,000 

Surplus   

.     50,000 

$150,000 

$150,000 

In  this  statement  we  are  carrying  the  plant  as  an  asset 
at  a  valuation  of  $70,000;  that  is  to  say,  we  show  the 
original  cost  ($100,000)  as  an  asset  and  the  estimated  amount 
of  the  depreciation  ($30,000)  as  a  liability,  making  a  net 
asset  of  $70,000. 

Now  we  will  assume  that  we  have  to  spend  $10,000  to 
replace  certain  machinery  which  is  worn  out.  The  entry  is 
as  follows: 

Dr.  Cr. 


Depreciation  of  Plant   $10,000 

Cash  


$10,000 


178 


PRINCIPLES    OF 


This  entry  does  not  affect  the  net  capital,  since  the  item 
under  the  head  of  Depreciation  of  Plant  has  already  been 
charged  out  as  a  loss,  and  losses  are  not  to  be  counted  twice. 
The  statement  therefore  takes  this  form: 


ASSETS 

LIABILITIES 

Miscellaneous    .... 

.  .  .  $115  000 

Miscellaneous 

$50  000 

Plant    

100  000 

Depreciation  of  Plant  t 

20,000 

Cash  

5  000 

Total    

$70  000 

Bal.    (Net  Capital)  

150,000 

Total    ...     . 

$220  000 

$220  000 

Bal.    (Net  Capital) 

.  .  .$150,000 

Capital   Stock    

$100,000 

Surplus 

50000 

$150,000 

$150,000 

In  this  statement  we  are  carrying  the  plant  at  a  valuation 
of  $80,000,  which  of  course  is  correct;  if  it  was  worth 
$70,000  in  the  first  statement  it  is  now  worth  $80,000,  since 
we  have  just  spent  $10,000  on  it. 

Here,  again,  the  reader  will  note  the  distinction  between 
the  legal  definition  and  the  bookkeeping  definition  of  the 
term  liability.  In  the  legal  sense  the  item  of  $20,000  under 
the  head  of  Depreciation  of  Plant  is  not  a  liability,  but  in 
the  bookkeeping  sense  it  is  a  liability.  In  the  legal  sense  of 
the  term  there  can  be  no  liability  except  a  debt  owed  to  a 
real  person  or  to  an  organization  of  real  persons ;  but  in  book- 
keeping a  debt  owed  to  an  imaginary  person  called  Deprecia- 
tion of  Plant  represents  a  real  liability,  just  as  a  debt  owed 
by  an  imaginary  person  called  Plant  represents  a  real  asset; 
and  because  it  does  represent  a  real  liability  it  partially  offsets 
the  real  asset.  In  ordinary  language  the  words  asset  and 
liability  are  nearly,  but  not  exactly,  opposite  in  meaning; 
but  in  double-entry  bookkeeping  they  are  exact  opposites, 
and,  therefore,  if  a  debt  owed  to  the  proprietor  by  an 


DOUBLE-ENTKY   BOOKKEEPING 


179 


imaginary  person  can  represent  a  real  asset,  a  debt  owed  by 
the  proprietor  to  an  imaginary  person  can  represent  a  real 
liability. 

The  accountant  can,  of  course,  conform  to  the  ordinary 
use  of  the  words  asset  and  liability  by  making  his  statement 
in  this  way: 


ASSETS 

LIABILITIES 

Miscellaneous                  $115  000 

Miscellaneous    

.  $50,000 

jriant 
Cost                  $100  000 

Total.  

.  $50,000 

Depreciation      20,000     80,000 
Cash                 ....               5  000 

Bal.   (Net  Capital)... 

.   150,000 

Total    $200  000 

$200,000 

Ral     <"N"pt  Pnnltall             $1  ^0  ftfift 

Capital  Stock   

$100,000 

Surplus    

50  000 

$150,000 

$150,000 

But  when  he  does  that  he  is  not  using  the  language  of 
double-entry  bookkeeping,  since  that  system  of  accounting 
excludes  subtraction;  it  always  uses  a  form  in  which  the 
two  sides  are  opposites,  and  therefore  a  deduction  is  to  be 
expressed,  not  by  subtracting  the  amount  from  the  one  side, 
but  by  adding  it  to  the  other  side.  I  would  not  be  under- 
stood, however,  as  saying  that  the  last  form  of  statement  is 
wrong;  on  the  contrary,  in  many  cases  it  is  preferable  to 
the  other.  When  the  people  for  whom  the  report  is  made 
do  not  understand  bookkeeping  language  it  is  better  to  use 
ordinary  language. 

In  the  current  practice  of  double-entry  bookkeeping  the 
accountant  makes  no  distinction  between  a  reserve  and  a 
liability;  in  fact,  regardless  of  the  evident  contradiction  in 
terms,  he  says  that  a  reserve  is  a  liability.  Owing  to  his 
confusion  of  thought  on  that  point  he  is  accustomed  to  treat 
depreciation  in  this  way :  At  the  end  of  each  period  he  debits 


180  PRINCIPLES    OF 

Profit  and  Loss  (or  Expense)  with  the  estimated  amount 
of  the  depreciation  and  credits  Depreciation  Reserve,  appar- 
ently blind  to  the  utter  absurdity  of  charging  out  an  item 
as  a  loss  and  then  calling  it  a  reserve.  If  the  bookkeeper 
wishes  to  say  that  the  loss  has  occurred,  he  should  debit 
Expense  and  credit  Depreciation  of  Plant,  and  carry  the 
item  as  a  liability.  But  if  he  wishes  to  say,  not  that  the 
loss  has  occurred,  but  that  it  is  expected  to  occur  in  the 
future,  he  should  debit  Surplus  and  credit  Depreciation 
Reserve,  and  carry  the  item  as  a  portion  of  the  net  capital 
reserved  to  meet  the  loss  when  it  occurs  or  if  it  occurs. 

Fire  Insurance: 

A  prepaid  premium  on  a  fire-insurance  policy  is  an  asset 
from  the  standpoint  of  the  policyholder  (and  a  liability  from 
the  standpoint  of  the  insurance  company),  but  it  is  an  asset 
which  constantly  diminishes,  and  disappears  when  the  time 
covered  by  the  policy  expires.  The  treatment  of  money  paid 
out  for  insurance  against  fire  is  therefore  very  simple.  At 
any  given  time  that  portion  of  the  premium  which  cor- 
responds to  the  unexpired  term  represents  asset  and  that 
portion  which  corresponds  to  the  time  which  has  expired 
represents  loss.  But  large  companies  whose  property  is 
scattered  often  carry  their  own  insurance;  or,  to  put  it  more 
accurately,  they  do  not  carry  any  insurance  at  all,  but  they 
make  provision  for  meeting  fire  losses.  In  this  case,  as  in 
the  case  of  depreciation,  there  are  two  ways  in  which  the 
account  may  be  kept. 

1.  At  the  end  of  each  period  we  debit  Expense  with  the 
estimated   amount   of  the  risk   and   credit  Insurance,   and 
carry  the  item  as  a  liability. 

2.  At  the  end  of  each  period  we  debit  Surplus  and  credit 
Insurance  Reserve,  and  carry  the  item  as  a  portion  of  the 
net  capital  reserved  to  meet  the  loss  when  it  occurs  or  if 
it  occurs. 


DOUBLE-ENTRY    BOOKKEEPING 


181 


But  there  is  this  difference  between  depreciation  and 
insurance:  Loss  by  depreciation  is  inevitable,  but  loss  by 
fire  is  not;  loss  by  depreciation  is  continuous,  but  loss  by  fire 
is,  at  most,  occasional.  At  any  given  time  it  is  proper  to 
assume  that  a  certain  loss  by  depreciation  has  already 
occurred,  but  it  is  not  proper  to  assume  that  a  loss  by  fire 
has  already  occurred  unless  property  has  actually  been 
destroyed  by  fire.  Therefore,  while  the  logical  way  to  treat 
depreciation  is  by  the  first  method,  the  logical  way  to  treat 
insurance  is  by  the  second  method. 

For  illustration  we  will  assume  that  at  the  end  of  each 
period  a  certain  company  makes  this  entry: 


Dr. 


Cr. 


Surplus     $5,000 

Insurance   Reserve    $5,000 


And  that  its  statement  is  now  as  follows : 


ASSETS 

LIABILITIES 

Miscellane 
Building  N 

DUB      

.$5,000,000 

Miscellaneous     

$1,000,000 

ro.  8  

20,000 

Total     

$1,000,000 
4,020,000 

Bal.    (Net   Capital). 

Total 

$5  020  000 

$5,020,000 

Bal.    (Net 

Capital)  . 

.$4,020,000 

Capital    Stock    

$3,000,000 
60,000 
960,000 

Insurance  Reserve   . 
Surplus        

$4,020,000 

$4,020,000 

If,  now,  Building  No.  8  is  destroyed  by  fire,  the  entries 
will  be  as  follows: 

Dr.  Cr. 

Profit  and  Loss   $20,000 

Building  No.  8   $20,000 

Insurance   Reserve    20,000 

Surplus     20,000 

18 


182 


PRINCIPLES    OF 


The  debit  to  Profit  and  Loss  is,  of  course,  finally  trans- 
ferred to  Surplus  and  cancels  the  credit  to  that  account; 
therefore  the  statement  takes  this  form: 


ASSETS 

LIABILITIES 

Miscellaneous 

$5  000  000 

Miscellaneous 

$1  000  000 

Total  

$1  000,000 

Bal.    (Net   Capital). 

.   4,000,000 

Total 

$5  000  000 

1 

$5,000,000 

Bal     (Net   Capital) 

$4  000  000 

Capital    Stock 

$3  000,000 

Insurance  Reserve 
Surplus                  .  .    . 

40,000 
.      960,000 

$4,000,000 

$4,000,000 

In  the  preceding  example  discarding  the  old  machinery 
did  not  affect  the  net  capital,  because  the  item  under  the 
head  of  Depreciation  of  Plant  had  already  been  charged  out 
as  a  loss;  but  in  this  example  the  destruction  of  the  building 
reduces  the  net  capital,  because  the  item  under  the  head  of 
Insurance  Reserve  has  never  been  charged  out  as  a  loss. 

Since  the  debit  to  Profit  and  Loss  is  finally  transferred  to 
Surplus  and  cancels  the  credit  to  that  account,  the  book- 
keeper often  omits  these  two  entries  and  simply  debits  Insur- 
ance Reserve  and  credits  Building  Xo.  8.  But  to  record  the 
destruction  of  the  building  in  that  way  is  entirely  wrong, 
because  it  hides,  or  at  all  events  it  fails  to  record,  a  loss 
of  $20,000.  Profit  and  Loss  is  the  statement  of  losses  and 
gains,  and  in  correct  accounting  every  loss  and  every  gain 
must  be  included  in  that  statement  (and  aside  from  contribu- 
tions and  withdrawals,  every  increase  of  net  capital  is  gain 
and  every  decrease  is  loss).  When  the  entries  are  made  as 
shown  in  our  example,  the  loss  due  to  the  destruction  of  the 
building  appears  in  the  profit  and  loss  statement;  but  it  does 
not  appear  there  when  the  bookkeeper  simply  debits  Insurance 


DOUBLE-ENTBY    BOOKKEEPING  183 

Keserve  and  credits  Building  No.  8.  In  that  case  the  books 
show  a  reduction  of  the  net  capital  without  any  record  of  the 
loss  in  the  statement  of  losses  and  gains. 

"Building  No.  8"  is  an  account  of  original  entry,  while 
Insurance  Eeserve  is  an  account  of  duplicate  entry,  and  it  is 
never  admissible  to  credit  an  account  of  original  entry  and 
debit  an  account  of  duplicate  entry,  except  to  record  a  with- 
drawal; nor  is  it  ever  admissible  to  debit  an  account  of 
original  entry  and  credit  an  account  of  duplicate  entry,  except 
to  record  a  contribution. 

There  is  a  general  test  which  can  be  applied  to  any  set 
of  books  to  cover  any  number  of  years.  If  the  books  have 
been  kept  correctly,  Profit  and  Loss  will  show  the  net  gain 
or  net  loss  and  the  accounts  of  duplicate  entry  will  show  the 
net  amount  contributed  or  withdrawn  during  each  period 
since  the  books  were  originally  opened.  By  combining  the 
periods  we  determine  the  net  gain  or  loss  and  the  net  amount 
contributed  or  withdrawn  during  the  whole  time  which  the 
books  cover.  We  now  take  the  net  capital  at  the  beginning, 
add  the  net  gain  or  subtract  the  net  loss,  add  the  net  amount 
contributed  or  subtract  the  net  amount  withdrawn,  and  com- 
pare the  result  with  the  net  capital  as  shown  at  the  present 
time.  If  the  two  amounts  do  not  agree,  the  books  have  not 
been  kept  correctly. 

The  reader  will  observe  that  if  in  the  example  given  above 
the  bookkeeper  records  the  loss  of  the  building  by  debiting 
Insurance  Reserve  and  crediting  Building  No.  8,  the  books 
will  not  conform  to  this  test;  there  will  be  a  discrepancy 
of  $20,000. 


184  PRINCIPLES    OF 

CHAPTER    XXII 

SINKING   FUNDS. 

A  sinking  fund  is  a  fund  which  is  accumulated  for  the 
purpose  of  paying  off  a  debt.  To  comply  with  this  definition 
the  fund  must  not  be  used  in  the  business,  but  must  be  set 
aside  to  the  end  that  when  the  debt  becomes  due  it  may  be 
paid  without  borrowing  money  and  without  injuring  the 
business.  A  so-called  sinking  fund  which  is  invested  in  the 
business  is  not  a  sinking  fund  at  all,  because  when  the  time 
comes  to  pay  the  debt  it  may  be  impossible  to  withdraw  the 
money  without  crippling  the  business. 

Any  fund  which  is  accumulated  for  the  purpose  of  paying 
off  a  debt  is  a  sinking  fund;  but  to  speak  of  accumulating 
such  a  fund  suggests  the  idea  of  a  debt  of  considerable  mag- 
nitude running  for  a  considerable  length  of  time,  and  since 
such  debts  are  usually  in  the  form  of  bonds,  the  term  sink- 
ing fund  is  generally  used  to  mean  a  fund  which  is  accumu- 
lated for  the  purpose  of  paying  off  bonds. 

In  this  connection  it  is  necessary  to  distinguish  clearly 
between  paying  a  debt  and  paying  it  off.  A  debt  due  to 
one  party  is  often  paid  by  borrowing  money  from  another 
party,  but  when  we  say  that  a  debt  is  paid  off  we  mean 
that  it  is  paid  without  incurring  a  new  debt.  Sinking  funds 
are  accumulated  only  in  connection  with  debts  which  are 
to  be  paid  off. 

In  the  case  of  the  great  majority  of  bonds  issued  by 
railroad  companies,  for  example,  there  is  no  intention  of 
paying  them  off,  and  there  is  no  reason  why  they  should  be 
paid  off.  The  intention  is  to  refund  them,  that  is  to  say, 
to  pay  them  when  they  mature  by  issuing  other  bonds  in 
their  place;  to  all  intents  and  purposes  the  bonds  are  per- 
petual. In  that  case,  of  course,  there  is  no  need  of  a  sinking 


DOUBLE-ENTRY    BOOKKEEPING  185 

fund;  but  if  a  company  issues  bonds  with  the  intention  of 
paying  them  off  when  they  become  due,  it  must  accumulate 
a  sinking  fund  for  the  purpose.  Moreover,  bonds  are  gen- 
erally issued  for  the  purpose  of  raising  money  to  make 
permanent  improvements,  and  money  which  has  been  invested 
in  that  way  cannot  be  taken  out  again  as  long  as  the  business 
continues,  since  the  company  cannot  sell  its  permanent 
improvements  without  going  out  of  business.  It  follows, 
therefore,  that  if  a  fund  is  to  be  accumulated  for  the  purpose 
of  paying  off  the  bonds,  it  must  be  accumulated  out  of  profits. 

In  many  cases  the  mortgage  or  trust  deed  under  which 
bonds  are  issued  requires  that  the  company  pay  a  certain 
amount  at  the  end  of  each  period  to  the  trustee  of  the  sink- 
ing fund,  and  also  requires  that  these  payments  be  made 
out  of  profits.  What  that  amounts  to  is  that  the  company 
binds  itself  not  to  distribute  any  dividends  which  would 
prevent  it  from  accumulating  profits  in  sufficient  amount  to 
pay  off  the  bonds  when  they  become  due.  In  other  words, 
it  binds  itself  to  deduct  the  amount  of  the  payment  to  the 
trustee  of  the  sinking  fund  before  considering  any  of  its 
net  income  as  available  for  dividends.  This  arrangement  is, 
of  course,  favorable  to  the  holders  of  the  bonds  in  question, 
and  of  other  bonds  which  the  company  may  have  issued,  since 
it  tends  to  strengthen  their  security. 

In  current  practice  the  title  "Sinking  Fund"  is  used 
as  the  heading  of  two  accounts,  one  an  account  of  original 
entry  and  the  other  an  account  of  duplicate  entry.  The  one 
represents  an  asset,  the  other  represents  a  portion  of  the 
net  capital  which  is  supposed  to  be  reserved  for  a  certain 
reason;  the  one  represents  a  concrete  thing,  the  other  repre- 
sents an  abstract  idea.  The  two  accounts,  then,  are  entirely 
distinct,  and  therefore  if  the  bookkeeper  had  an  accurate 
nomenclature  he  would  not  carry  them  both  under  the  same 
heading.  Some  accountants  recognize  that  fact  and  propose 
to  remedy  the  matter  by  calling  one  of  them  "Sinking  Fund" 


186  PRINCIPLES    OF 

and  the  other  "Sinking  Fund  Account";  but  since  both  of 
them  are  accounts,  that  would  only  add  to  the  confusion. 
The  proposal  to  distinguish  between  two  accounts  by  calling 
one  of  them  an  account,  strikingly  illustrates  the  vagueness 
of  the  bookkeeper's  ideas.  In  our  discussion,  in  order  to 
avoid  ambiguity,  we  will  call  the  account  of  original  entry 
"Sinking  Fund"  and  the  account  of  duplicate  entry  "Sinking 
Fund  Reserve."  The  latter  is  not  a  very  satisfactory  form 
of  expression,  but  at  all  events  it  has  the  advantage  of  brevity 
and  serves  to  indicate  that  the  account  represents  not  a 
concrete  thing,  but  an  abstract  or  imaginary  subdivision  of 
the  net  capital. 

When  both  accounts  are  carried  under  the  heading 
"Sinking  Fund,"  the  only  way  to  tell  one  from  the  other  is 
by  the  fact  that  the  balance  is  brought  down  as  a  debit  in 
the  account  of  original  entry,  and  as  a  credit  in  the  account 
of  duplicate  entry.  The  bookkeeper  classes  the  balance  of 
the  account  of  original  entry  as  an  asset,  which  of  course 
is  correct,  since  it  represents  the  cash  and  securities  which 
compose  the  sinking  fund;  but  he  classes  the  balance  of  the 
account  of  duplicate  entry  as  a  liability,  which  is  an  absurdity. 
The  sinking  fund  is  accumulated  for  the  purpose  of  paying 
off  the  principal  of  the  bonds;  it  has  nothing  to  do  with  the 
interest.  Now  the  whole  liability  and  the  only  liability  in 
connection  with  the  principal  of  the  bonds  is  shown  under 
the  heading  "Bonds"  or  "Funded  Debt";  therefore,  if  the 
balance  which  is  brought  down  as  a  credit  under  the  heading 
"Sinking  Fund"  is  also  classed  as  a  liability,  the  bookkeeper 
is  counting  the  same  liability  twice. 

The  term  sinking  fund  is  apt  to  call  up  visions  of  com- 
pound interest,  but  we  have  nothing  to  do  with  that  part  of 
the  subject  here,  since  the  only  purpose  of  our  present  dis- 
cussion is  to  explain  the  difference  between  the  account  of 
original  entry  which  is  carried  under  the  heading  "Sinking 
Fund"  and  the  account  of  duplicate  entry  which  is  often 


DOUBLE-ENTRY    BOOKKEEPING  187 

carried  under  the  same  heading.  The  connection  between 
sinking  funds  and  compound  interest  is  not  essential,  it  is 
merely  incidental,  and  is  due  to  the  fact  that  the  accumula- 
tion of  a  sinking  fund  is  usually  the  work  of  years.  For 
that  reason,  as  the  money  gradually  accumulates,  it  will  not 
be  allowed  to  lie  idle,  but  will  be  put  out  at  interest,  thus 
reducing  the  amount  to  be  set  aside  at  the  end  of  each 
period.  Assuming  that  all  the  money  will  earn  a  certain 
rate  of  interest  all  the  time,  it  is  easy  to  determine  either 
by  calculation  or  from  tables  which  give  the  results  of  the 
calculations,  the  sum  which  must  be  added  to  the  sinking 
fund  at  the  end  of  each  period  in  order  to  make  the  contribu- 
tions and  the  interest  amount  to  the  required  sum  at  the 
end  of  the  specified  time.  Since  the  calculation  may  be 
based  upon  any  assumed  rate  of  interest,  and  since  the 
question  of  interest  does  not  enter  into  our  discussion,  we  will 
assume  for  the  sake  of  simplicity  that  the  interest  rate  is 
zero.  In  that  case  the  amount  to  be  added  to  the  sinking 
fund  at  the  end  of  each  period  equals  the  total  amount  of  the 
debt  divided  by  the  number  of  periods. 

To  illustrate  the  two  accounts  which  are  under  discus- 
sion we  will  take  the  case  of  a  company  that  has  issued  bonds 
to  the  amount  of  $1,000,000  payable  in  twenty  years.  If 
the  company  intends  to  pay  off  the  bonds  when  they  mature 
it  must  accumulate  a  sinking  fund  for  the  purpose,  and  in 
order  to  do  that  (if  we  disregard  the  interest  on  the  accumu- 
lations) it  should  put  $25,000  in  cash  or  its  equivalent  into 
the  sinking  fund  at  the  end  of  each  half  year.  At  the  close 
of  each  period,  then,  the  bookkeeper  will  make  these  entries : 

Dr.  Cr. 

Sinking    Fund    $25,000 

Cash,     $25,000 

Surplus     25,000 

Sinking  Fund  Reserve 25,000 


188 


PRINCIPLES    OF 


At  the  end  of  five  years  the  statement  of  the  company 
will  be  in  this  form : 


ASSETS 

LIABILITIES 

Miscellaneous  

.  .$3,400,000 

Miscellaneous 

$100  000 

Sinking  Fund   

250,000 

Bonds 

1  000  000 

Total 

$1  100  000 

Bal.    (Net   Capital).. 

2,550,000 

Total     

.  .$3,650,000 

$3  650  000 

Bal.   (Net  Capital) 

.  .$2,550,000 

Capital    Stock 

$2  000  000 

Sinking  Fund  Reserve 
Surplus      

250,000 
300  000 

$2,550,000 


$2,550,000 


It  will  be  noted  that  in  the  two  accounts,  Sinking  Fund 
and  Sinking  Fund  Reserve,  we  are  simply  recording  the  same 
thing  twice,  once  in  concrete  form  and  again  in  abstract  form, 
once  as  an  asset  and  again  as  a  portion  of  the  net  asset. 

If  the  headings  were  written  in  full,  the  account  of 
original  entry  would  appear  in  the  ledger  in  this  form: 


Dr. 


Sinking  Fund 
To    Company 


Cr. 


$250,000 


And  the  account  of  duplicate  entry  would  be  in  this  form : 

Dr.  Company  (Sinking  Fund  Reserve)  Cr. 

To  Outside  Parties 


$250,000 


The  first  account  means  that  the  outside  party  called 
Sinking  Fund  owes  $250,000  to  the  company.  Since  the  debt 
is  good  it  represents  an  asset. 


DOUBLE-ENTBY   BOOKKEEPING 


189 


The  second  account  means  that  the  company  is  owed 
$250,000  by  the  outside  parties  collectively.  Since  the  debt 
is  good  it  represents  a  portion  of  the  net  asset. 

At  the  time  when  the  bonds  mature  the  statement  of  the 
company  will  be  in  this  form: 


ASSETS 

LIABILITIES 

Miscellaneous     .... 

.  .$3,600,000 

Miscellaneous 

$200,000 
1,000  000 

Sinking  Fund    .... 

.  .   1,000,000 

Bonds   

Total      .  .         

$1,200,000 
.   3.400,000 

Bal.    (Net  Capital). 

Total 

$4  600  000 

$4,600,000 

Bal.    (Net  Capital) 

..$3,400,000 

Capital    Stock    

.$2.000.000 

Sinking   Pd.    Reserve  1,000,000 
Surplus    400.000 

* 

$3,400,000 

$3,400,000 

When  the  company  pays  off  the  bonds  the  entries,  accord- 
ing to  current  practice,  are  as  follows : 

Dr.  Cr. 

Bonds    $1,000,000 

Sinking  Fund   $1,000,000 

Sinking  Fund  Reserve    1,000,000 

Surplus    1,000,000 

The  first  two  entries  balance  the  accounts  under  the 
headings  "Bonds"  and  "Sinking  Fund."  The  third  entry 
balances  the  account  under  the  heading  "Sinking  Fund 
Reserve,"  and  therefore  we  get  rid  of  that  title,  which  of 
course  is  no  longer  needed,  since  the  bonds  have  now  been 
paid.  But  the  entry  crediting  Surplus  is  apt  to  give  the 
impression  that  paying  the  bonds  releases  capital  and  makes 
it  available  for  distribution,  which  is  wrong.  The  proceeds 
of  the  bonds  were  invested  in  permanent  improvements  and 
therefore  the  money  cannot  be  withdrawn  from  the  business, 


190 


PRINCIPLES    OF 


no  matter  whether  the  bonds  have  been  paid  or  not.     It 
would  be  better,  then,  to  make  the  entries  in  this  way : 

Dr.  Cr. 

Bonds    $1,000,000 

Sinking  Fund   $1,000,000 

Sinking  Fund  Reserve  1,000,000 

Profits  Invested  in  Improvements  1,000,000 

These  entries  convey  the  right  idea.  Formerly  we  had 
$1,000,000  of  borrowed  capital  invested  in  permanent 
improvements;  now,  having  paid  off  the  debt  out  of  profits, 
we  have  $1,000,000  of  accumulated  profits  invested  in  perma- 
nent improvements. 

The  statement  then  takes  this  form : 


ASSETS 

LIABILITIES 

Miscellaneous     ...    . 

.$3  600,000 

Miscellaneous     

$200,000 

Total 

$200  000 

Bal.   (Net  Capital)    .  . 

3,400,000 

Total  

$3  600  000 

$3  600  000 

Bal.   (Net  Capital)    . 

.$3  400  000 

Capital   Stock    

$2,000,000 

Profits     Invested     in 
Improvements    
Surplus      

1,000,000 
400,000 

$3,400,000 

$3,400,000 

In  order  to  avoid  incongruity  in  the  use  of  language 
when  speaking  of  the  net  capital,  it  is  necessary  to  distinguish 
clearly  between  those  operations  which  affect  the  net  capital 
and  those  which  do  not.  We  may  speak  of  a  portion  of  the 
net  capital  which  is  to  be  used  to  pay  dividends  or  which  is 
not  to  be  used  to  pay  dividends,  because  paying  dividends 
reduces  the  net  capital.  We  may  speak  of  a  portion  of  the 
net  capital  as  reserved  to  meet  a  liability  which  is  expected 
to  accrue  in  the  future,  because  the  accruing  of  the  liability 
will  reduce  the  net  capital.  But  to  speak  of  a  portion  of  the 


DOUBLE-ENTRY    BOOKKEEPING 


191 


net  capital  as  reserved  to  pay  outstanding  bonds  would  be 
an  absurdity;  paying  an  existing  debt  does  not  affect  the  net 
capital  one  way  or  the  other,  it  reduces  both  the  assets  and 
the  liabilities  by  the  same  amount. 

"Sinking  Fund  Reserve,"  then,  does  not  mean  a  portion 
of  the  net  capital  which  is  to  be  used  to  pay  the  bonds,  it 
means  a  portion  of  the  net  capital  which  is  not  to  be  used  to 
pay  dividends;  in  other  words,  it  means  a  portion  of  the  net 
capital  which  is  to  remain  invested  in  the  business. 

Sometimes  a  company  which  has  issued  bonds  does  not 
set  aside  a  special  fund  for  the  purpose  of  paying  them  off, 
but  does  take  measures  to  accumulate  profits  to  an  extent 
equal  to  the  amount  of  the  bonds.  In  that  case  (if  we  follow 
the  bookkeeper's  practice  of  using  the  term  "Sinking  Fund" 
as  the  heading  of  the  account  of  duplicate  entry  as  well  as 
of  the  account  of  original  entry)  the  entries  at  the  end  of 

each  period  would  be  in  this  form : 


Dr. 


Cr. 


Surplus    $25,000 

Sinking  Fund   $25,000 

At  the  time  when  the  bonds  mature  the  statement  would 
be  as  follows: 


ASSETS 

LIABILITIES 

Miscellaneous     

.$4,600,000 

Miscellaneous     

$200  000 

Bonds     

1,000,000 

Total 

$1  200  000 

Bal.    (Net   Capital). 

.   3,400,000 

Total     

.$4,600,000 

$4,600,000 

Bal     (Net   Capital) 

$3  400  000 

Capita]  Stock  

.$2,000,000 

Sinking  Fund 

1  000  000 

Surplus    

400  000 

$3,400,000 

$3,400,000 

192  PRINCIPLES    OF 

It  will  be  noted,  however,  that  this  statement  does  not 
show  whether  the  company  is  prepared  to  pay  off  its  bonds 
or  not.  In  practice  the  list  of  assets  would  be  given  in 
detail  and  that  would  show  the  condition  of  the  company  in 
regard  to  the  bonds ;  that  is  to  say,  it  would  show  whether  the 
company  has  available  assets  in  sufficient  amount  to  pay 
them  off.  But  the  item  under  the  head  of  "Sinking  Fund" 
does  not  show  it.  All  that  that  item  shows  is  that  the  com- 
pany has  reserved  profits  to  an  extent  equal  to  the  amount  of 
the  bonds ;  but  the  item  is  an  abstract  number  and  therefore 
does  not  show  how  the  reserved  profits  are  invested.  If  its 
assets  are  good  the  company  can,  no  doubt,  borrow  money 
to  pay  the  bonds,  that  is  to  say,  it  can  refund  them;  but  it 
cannot  pay  them  off  unless  it  has  cash  or  its  equivalent 
available  for  the  purpose. 

When  the  account  is  carried  in  this  way  the  officers  and 
stockholders  of  the  company  are  apt  to  have  the  idea  that 
when  they  tell  the  bookkeeper  to  debit  Surplus  and  credit 
Sinking  Fund  they  are  making  provision  for  paying  off  the 
bonds.  That  idea  is  entirely  wrong.  A  transfer  from  Surplus 
to  Sinking  Fund  is  merely  a  book  transfer ;  it  is  an  imaginary 
transfer  of  a  portion  of  the  net  capital  from  one  account  of 
duplicate  entry  to  another.  It  provides  against  the  dis- 
tribution of  dividends  which  would  prevent  the  accumulation 
of  profits  to  an  extent  equal  to  the  amount  of  the  bonds; 
but  it  does  not  provide  for  accumulating  the  profits  in  such 
form  as  to  be  available  for  paying  off  the  bonds.  If  the 
accumulation  of  profits  is  used  to  enlarge  the  business,  it 
is  very  evident  that  it  cannot  be  used  to  pay  off  the  bonds, 
although  it  may  make  it  easier  to  refund  them. 

Since  bonds  are  generally  issued  for  the  purpose  of  raising 
money  to  make  permanent  improvements,  the  custom  of 
carrying  an  account  of  duplicate  entry  under  the  heading 
"Sinking  Fund"  probably  had  its  origin  in  the  idea  of 
depreciation,  the  idea  that  the  value  which  the  so-called 


DOUBLE-ENTRY    BOOKKEEPING  193 

permanent  improvements  will  have  at  the  time  when  the 
bonds  mature,  is  so  uncertain  that  in  determining  the  ques- 
tion of  dividends  it  should  be  left  out  of  consideration 
altogether.  In  other  words,  the  idea  is  that  no  dividends 
should  be  declared  unless  the  business  is  sufficiently  prosper- 
ous to  pay  both  the  interest  and  the  principal  of  the  bonds 
and  dividends  besides.  The  object  of  the  account  of  duplicate 
entry  is  to  insure  the  carrying  out  of  that  policy.  At  the 
end  of  each  period  we  determine  the  net  income,  which  is  the 
difference  between  the  net  capital  at  the  close  and  the  net 
capital  at  the  beginning  of  the  period.  This  net  income  is 
over  and  above  the  interest  on  the  'bonds,  since  that  has 
already  been  paid  and  charged  out  as  a  loss.  If,  now,  out  of 
this  net  income  we  can  reserve  the  amount  which  should  be 
put  into  the  sinking  fund  to  pay  the  principal  of  the  bonds 
and  still  have  something  left,  it  is  proper  to  declare  a  divi- 
dend; otherwise  it  is  not. 

No  doubt  the  practice  of  carrying  an  account  of  duplicate 
entry  under  the  heading  "Sinking  Fund"  originated  before 
it  was  customary  to  make  a  formal  allowance  for  depreciation, 
as  is  done  nowadays.  If  before  declaring  a  dividend  we 
allow  for  the  payment  of  the  proper  proportion  of  the  prin- 
cipal of  the  bonds  and  also  allow  for  the  depreciation  in  the 
value  of  the  permanent  improvements  for  which  the  bonds 
were  issued,  it  is  very  evident  that  we  "make  assurance  double 


194 


PRINCIPLES    OF 


CHAPTER    XXIII 

STATEMENT   OF   A   RAILROAD   COMPANY. 

The  statement  given  below  follows  the  form  of  a  report 
published  by  one  of  the  great  railroad  corporations  under 


THE  A.  &  B.  RAILROAD  COMPANY 
CONDENSED  GENERAL  BALANCE  SHEET 

ASSETS 
Property   Investment: 

1.  Road     $263,000,000 

2.  Equipment    133,000,000     $396,000,000 


3.  Securities   owned    

4.  Securities  under  lease  of  C.  &  D.  Railroad  .... 

5.  Advances  to  proprietary,  affiliated  and  controlled 

companies     

6.  Miscellaneous    investments    

7.  Cash    

8.  Materials  and  supplies   

9.  Cash  and  securities  in  sinking,  insurance  and 

other  reserve  funds    

10.  Cash  and  securities  in  employees  and  provident 

funds    

11.  Various  other  assets   . 


280,000,000 
3,000,000 

41,000,000 

1,000,000 

32,000,000 

15,000,000 

31,000,000 

6,000,000 
30,000,000 


$835,000,000 


DOUBLE-ENTKY   BOOKKEEPING  195 

date  of  December  31,  1910.  It  may  be  taken,  therefore,  as 
representing  current  practice. 

In  the  example  the  items  have  been  numbered  for  con- 
venience of  reference,  and  the  names  and  amounts  have  been 
changed  because  it  is  easier  to  give  and  to  read  the  amounts 
in  round  millions. 

It  will  be  noted  that  in  this  statement  the  title  "Profit 
and  Loss"  is  used  in  the  sense  in  which  we  have  been  using 
the  title  "Surplus." 


THE  A.  ft  B.  RAILROAD  COMPANY 
CONDENSED  GENERAL  BALANCE  SHEET 

LlABHJTIES 

12.  Capital  Stock  $412,000,000 

13.  Premium  realized  on  capital  stock 7,000,000 

14.  Bonded  and  secured  debt   $163,000,000 

15.  Funded    debt    of    companies    whose 

properties  have  been  acquired  by 

the  A.  &  B.  Railroad  Co 54,000,000 

16.  Guaranteed  stock  trust  certificates  of 

the  E.  &  F.  Railroad  Co 15,000,000 

17.  Equipment  trust  obligations    34,000,000 

18.  Mortgages  and  ground  rents  payable      4,000,000      270,000,000 

19.  Securities  received  with  the  lease  of  the  C.  &~D7~ 

Railroad    3,000,000 

20.  Liability  on  account  of  employees  and  provident 

funds     6,000,000 

21.  Various   liabilities    43,000,000 

22.  Additions  to  property  through  income   27,000,000 

Reserves  from  Income  or  Surplus: 

23.  Invested  in  sinking,  redemption  and 

other  reserve  funds    $32,000,000 

24.  Car  trust  principal  charged  out  in 

advance    and    reserves    for    addi- 
tions and  betterments   8,000,000        40,000,000 


25.  Profit  and  Loss  27,000,000 

$835,000,000 


196  PRINCIPLES    OF 

In  such  reports  the  descriptions  are  necessarily  con- 
densed and  in  some  cases  they  do  not  explain  fully  the 
nature  of  the  items.  For  that  very  reason  the  accountant, 
the  man  whose  business  it  is  to  know  what  the  items  mean, 
should  classify  them  in  such  a  way  that  the  stockholders  can 
tell  what  they  mean.  The  writer  does  not  profess  to  be  able 
to  give  an  authoritative  interpretation  of  the  statement,  it 
would  take  an  expert  railroad  accountant  to  do  that;  but 
we  can  discuss  it  tentatively,  and  that  is  all  that  is  needed 
here,  since  our  only  object  is  to  point  out  the  principles  upon 
which  the  classification  of  the  items  should  be  based. 

It  will  facilitate  the  discussion  to  keep  these  facts  in 
mind : 

1.  The  statement  deals  with  the  affairs  of  the  company, 
and  the  stockholders  are  the  company ;  therefore  an  item  does 
not  represent  asset  or  liability  unless  it  represents  asset  or 
liability  from  the  standpoint  of  the  stockholders. 

2.  In  order  to  appear  on  such  a  statement  an  item  must 
represent  either  asset  or  liability  or  net  capital;  it  cannot 
represent  anything  else.     There  may  be  cases  (like  items  4 
and   19  and  items  10  and  20)    in  which  two  items  taken 
together  cancel  each  other  and  therefore,  jointly,  represent 
neither  asset  nor  liability;  but  taken  separately  each  item 
represents  either  an  asset  or  a  liability. 

3.  Every  item  on  the  one  side  must  represent  either  asset 
or  negative  net  capital,  and  every  item  on  the  other  side  must 
represent  either  liability  or  positive  net  capital. 

In  our  example,  all  of  the  items  under  the  heading 
"Assets"  evidently  represent  asset,  therefore  we  need  only 
to  discuss  the  items  under  the  heading  "Liabilities."  In 
regard  to  each  of  these  items  the  only  question  is  whether  it 
represents  liability  or  not;  if  it  does  not  represent  liability 
it  must  represent  net  capital,  since  the  net  capital  is  the 
difference  between  the  assets  and  the  liabilities. 


DOUBLE-ENTRY   BOOKKEEPING  197 

So  far  as  one  can  judge  from  the  descriptions  which  are 
given,  items  12,  13,  22,  23,  24  and  25  do  not  represent 
liability  from  the  standpoint  of  the  stockholders,  and  there- 
fore they  do  not  represent  liability  at  all;  they  represent  net 
capital. 

Items  12  and  13  show  portions  of  the  net  capital  which 
are  to  be  reserved  from  distribution  as  representing  the 
amount  contributed  by  the  stockholders. 

Item  22  shows  a  portion  of  the  net  capital  which  must 
be  reserved  from  distribution  because  that  amount  of  the 
profits  has  been  invested  in  permanent  improvements. 

Item  23  shows  a  portion  of  the  net  capital  which  is  to 
be  reserved  from  distribution  because  the  company  must 
accumulate  profits  in  order  to  pay  off  some  of  its  bonds, 
the  proceeds  of  which  were  invested  in  permanent  improve- 
ments. 

Item  24  shows  $8,000,000  under  the  heading  "Car  trust 
principal  charged  out  in  advance,  and  reserves  for  additions 
and  betterments."  The  first  part  of  that  heading  probably 
means  that  the  company  has  decided  to  reserve  a  portion  of 
its  net  capital  from  distribution  because  it  intends  to  make 
a  payment  out  of  profits  on  the  debt  shown  in  item  17,  under 
the  heading  "Equipment  trust  obligations";  and  the  second 
part  of  it  means  that  the  company  has  decided  to  reserve  a 
certain  amount  of  its  net  capital  from  distribution  because 
it  intends  to  invest  a  portion  of  its  profits  in  permanent 
improvements. 

Item  25  shows  the  remainder  of  the  net  capital  after 
all  of  the  amounts  indicated  above  as  reserved  have  been 
deducted. 

Assuming  that  our  understanding  of  the  matter  is  correct, 
the  statement  should  be  made  in  this  form : 

14 


198 


PRINCIPLES    OF 


THE  A.  &  B.  RAILROAD  COMPANY 
CONDENSED  GENERAL  BALANCE  SHEET 

ASSETS 
Property  Investment: 

Road     $263,000,000 

Equipment    133,000,000     $396,000,000 


Securities  owned  

Securities  under  lease  of  C.  &  D.  Railroad 

Advances  to  proprietary,  affiliated  and  controlled 

companies 

Miscellaneous  investments  

Cash  

Materials  and  supplies  

Cash  and  securities  in  sinking,  insurance  and  other 

reserve  funds  

Cash  and  securities  in  employees  and  provident 

funds  

Various  other  assets  . 


280,000,000 
3,000,000 

41,000,000 

1,000,000 

32,000,000 

15,000,000 

31,000,000 

6,000,000 
30,000,000 


Total    $835,000,000 

Balance  (Net  Capital)    $513,000,000 


$513,000,000 


DOUBLE-ENTRY    BOOKKEEPING 


199 


THE  A.  &  B.  RAILROAD  COMPANY 
CONDENSED  GENERAL  BALANCE  SHEET 

LIABILITIES 

Bonded  and  secured  debt  $163,000,000 

Funded  debt  of  companies  whose  prop- 
erties have  been  acquired  by  the 

A.  &  B.  Railroad  Co 54,000,000 

Guaranteed    stock    trust    certificates    of 

the  E.  &  F.  Railroad  Co 15,000,000 

Equipment  trust  obligations   34,000,000 

Mortgages  and  ground   rents  payable..       4,000,000     $270,000,000 

Securities  received  with  the  lease  of  the  C.  &  D. 

Railroad  3,000,000 

Liability  on  account  of  employees  and  provident 

funds  6,000,000 

Various  liabilities  43,000,000 

Total    $322,000,000 

Balance    (Net  Capital)    513,000,000 

$835,000,000 

Capital  Stock    $412,000,000 

Premium  realized  on  capital  stock 7,000,000 

Contributed   Capital    $419,000,000 

Additions  to  property  through  income  . .   $27,000,000 

Sinking,  redemption  and  other  reserve 

funds  32,000,000 

Car  trust  principal  charged  out  in  ad- 
vance and  reserves  for  additions 
and  betterments  8,000,000 

Profit  and  Loss   27,000,000 

Accumulated  Profits   94,000,000 

$513,000,000 


200  PRINCIPLES    OF 

This  form  of  statement  gives  the  information  which  the 
stockholder  wants.  It  gives  the  assets  in  detail  and  the 
total  of  the  assets  and  the  liabilities  in  detail  and  the  total 
of  the  liabilities;  it  also  gives  the  total  amount  of  the  net 
capital  and  shows  how  it  is  supposed  to  be  divided.  From 
such  a  statement  the  stockholder  can  readily  calculate  the 
book  value  of  a  share  of  stock.  If  the  par  value  of  a  share 
of  stock  is  $100,  capital  stock  of  $412,000,000  represents 
4,120,000  shares.  The  net  capital  is  $513,000,000;  there- 
fore the  book  value  of  a  share  of  stock  equals  $513,000,000 
divided  by  4,120,000,  equals  $124.51. 

The  objection  might  be  raised  that  a  statement  in  this 
form  would  tend  to  give  the  stockholders  an  exaggerated 
idea  of  the  value  of  the  stock ;  but  as  a  matter  of  fact,  in  the 
case  of  a  railroad  company  at  any  rate,  it  would  simply  afford 
a  means  of  comparing  the  book  value  with  the  quoted  market 
value. 

People  who  know  anything  at  all  about  business  matters 
know  that  to  a  very  great  extent  bookkeeping  necessarily 
deals  with  estimated  values;  they  know,  therefore,  that  a 
statement  of  this  kind  is  at  best  a  careful  estimate  of  the 
value  of  the  property.  In  railroad  accounting  it  is  customary 
to  estimate  the  value  of  the  road  at  what  it  cost  to  construct 
it,  the  idea  being  that  the  expenditure  for  maintenance  (which 
is  charged  out  as  an  expense)  will  keep  the  road  up  to  its 
original  value.  But  sometimes  it  may  do  more  than  that; 
it  may  improve  the  road.  In  that  case  the  question  arises 
whether  any  excess  of  expenditure  over  what  is  required  to 
keep  the  property  in  its  original  condition  should  be 
regarded  as  an  investment  or  as  an  expense.  Theoretically, 
of  course,  it  should  be  regarded  as  an  investment ;  but  prac- 
tically it  might  be  better  to  regard  it  as  an  expense.  Under 
ordinary  conditions  the  estimated  value  of  the  assets  is  never 
exactly  correct;  it  is  always  either  too  low  or  too  high,  and 
from  a  business  point  of  view  it  is  generally  considered  safer 


DOUBLE-ENTRY   BOOKKEEPING  201 

to  have  the  estimate  low  rather  than  high.  When  the  value 
of  the  assets  is  overestimated  (and  we  will  assume  that  the 
estimate  is  made  in  good  faith)  the  danger  is  that  excessive 
dividends  may  be  declared,  and  when  the  officers  and  stock- 
holders of  the  company  wake  up  to  the  fact  that  they  have 
been  overvaluing  their  assets,  they  may  find  that  they  have 
distributed  not  only  their  profits  but  also  a  portion  of  their 
contributed  capital;  in  other  words,  they  may  find  that  their 
capital  is  impaired.  For  that  reason  conservative  business 
men  are  inclined  to  advocate  the  policy  of  not  adding  any- 
thing to  the  estimated  value  of  the  property  except  for  exten- 
sions. The  whole  question,  however,  is  largely  a  matter  of 
opinion  and  therefore  it  must  be  settled  by  authority — in 
the  case  of  railroad  companies,  by  the  authority  of  the  law. 

In  our  example,  the  item  of  $27,000,000  under  the  head- 
ing "Additions  to  property  through  income"  would  indicate 
that  railroad  companies  are  expected  to  add  to  the  estimated 
value  of  the  property  any  expenditure  on  it  in  excess  of  what 
is  needed  to  keep  it  in  its  original  condition,  but  at  the  same 
time  they  are  to  record  a  corresponding  portion  of  the  net 
capital  as  reserved  from  distribution.  That  method  of  keep- 
ing the  accounts  may  possibly  lead  to  an  overvaluation  of 
assets;  but  it  will  not  lead  to  an  excessive  distribution  of 
dividends,  nor  will  it  lead  to  overcapitalization.  What  is 
commonly  called  "overcapitalization"  is  brought  about  by 
overvaluing  the  assets  and  then  issuing  stock  to  correspond 
with  the  imaginary  increase  of  net  capital.  But  in  our 
example,  whatever  amount  is  added  to  the  estimated  value 
of  the  assets,  a  corresponding  amount  of  the  net  capital 
must  be  indicated  as  reserved  under  the  heading  "Additions 
to  property  through  income";  therefore  that  portion  of  the 
net  capital  cannot  be  distributed  in  dividends,  nor  can  stock 
be  issued  against  it. 

If  this  sum  of  $27,000,000,  instead  of  being  counted  as 
an  investment  and  added  to  the  estimated  value  of  the  prop- 


202  PRINCIPLES    OF 

erty,  had  been  charged  out  as  an  expense,  the  total  of  the 
assets  would  be  $27,000,000  less  and  the  total  amount  of  the 
net  capital  would  be  $27,000,000  less.  The  amount  of  the 
net  capital,  then,  would  be  $486,000,000,  and  the  book  value 
of  a  share  of  stock  would  be  $486,000,000  divided  by  4,120,- 
000,  equals  $117.96. 

So  far,  we  have  based  the  discussion  entirely  upon  the 
apparent  meaning  of  the  items,  without  reference  to  the 
principles  of  double-entry  bookkeeping  which  are  involved  in 
the  matter;  but  the  connection  between  the  principles  of 
double-entry  bookkeeping  and  the  meaning  of  the  items  is 
very  evident.  All  of  the  items  under  the  heading  "Assets" 
are  made  up  of  balances  brought  down  as  debits  in  accounts 
of  original  entry,  and  all  of  the  items  under  the  heading 
"Liabilities"  are  made  up  of  balances  brought  down  as 
credits  in  accounts  of  original  entry.  In  every  such  account 
one  of  the  outside  parties  is  the  first  party  and  the  com- 
pany is  the  second  party;  therefore  a  balance  brought  down 
as  a  debit  records  a  debt  owed  by  an  outside  party  to  the 
company,  and  a  balance  brought  down  as  a  credit  records  a 
debt  owed  to  an  outside  party  by  the  company.  Since  only 
good  debts  are  brought  down  to  new  account,  these  balances 
represent  the  assets  and  liabilities  of  the  company. 

The  items  showing  the  way  in  which  the  net  capital  is 
supposed  to  be  divided  are  made  up  of  balances  brought  down 
as  credits  in  accounts  of  duplicate  entry.  In  every  such 
account  the  company  is  the  first  party  and  the  outside  parties 
collectively  are  the  second  party;  therefore  a  balance  brought 
down  as  a  credit  records  all  or  part  of  the  net  good  debt 
owed  to  the  company  by  the  outside  parties  collectively,  and 
the  net  good  debt  owed  to  the  company  by  the  outside  parties 
collectively  represents  its  net  capital. 


UOUBLE-ENTRY    BOOKKEEPING  203 

CHAPTER    XXIV 

CONCLUSION. 

It  is  not  likely  that  anyone  will  attempt  to  controvert  the 
theory  developed  in  the  preceding  chapters;  its  truth  is 
beyond  question.  There  is  not  a  weak  link  in  the  chain  of 
the  argument;  the  logic  is  absolutely  unassailable.  But  some 
may  ask :  Of  what  use  is  it  ?  To  the  man  who  is  unable  to 
think  clearly,  and  therefore  is  unable  to  appreciate  the  value 
of  clear  thinking,  it  is  of  no  use  at  all.  If  such  a  man  wishes 
to  become  a  bookkeeper,  the  only  thing  for  him  to  do  is  to 
learn  the  art  in  the  old-fashioned  way,  to  learn  it  by  rote 
and  to  do  as  he  is  told.  But  fortunately  bookkeepers  are  not 
all  of  that  class.  In  the  great  field  of  accounting  are  to  be 
found  men  who  rank  with  the  best  in  any  vocation,  who  have 
ability  enough  to  carry  the  practical  application  of  their  art 
to  its  highest  development,  and  also  have  intelligence  enough 
to  know  that  double-entry  bookkeeping,  as  it  has  always  been 
taught  and  practiced,  has  no  rational  basis.  These  are  the 
men  who  will  appreciate  the  value  of  a  theory  which  places 
double-entry  bookkeeping  upon  an  equal  footing  with  other 
branches  of  applied  mathematics,  thus  opening  the  way  for 
accountants  to  raise  their  occupation  to  the  dignity  of  a 
profession. 

What  causes  the  current  practice  of  double-entry  book- 
keeping to  be  regarded  by  all  intelligent  persons  as  outside 
the  pale  of  common  sense  is  the  absurdity  of  its  language — 
a  language  which  violates  the  laws  of  rational  speech  in 
that  it  uses  relative  terms  from  a  double  standpoint.  Men 
who  use  such  a  language,  who  charge  out  an  item  as  a  loss 
and  then  call  it  a  reserve,  who  say  that  surplus  is  a  liability 
and  then  say  that  increase  in  the  amount  of  the  surplus  is 
gain,  who  call  net  asset  a  liability  and  net  liability  an  asset 


204  PRINCIPLES    OF 

— men  whose  commonest  form  of  expression  is  a  contradic- 
tion in  terms — will  never  be  recognized  as  practicing  a 
profession. 

What  this  treatise  has  accomplished  is  to  prove  that 
double-entry  bookkeeping  is  a  rational  process  and  therefore 
does  not  involve  the  necessity  of  using  irrational  language; 
that  the  ledger  form  of  debit  and  credit  has  a  meaning  broad 
enough  to  cover  all  the  purposes  of  accounting,  and  that  every 
account  is  kept  strictly  in  accordance  with  the  meaning  of 
the  form;  that  double-entry  bookkeeping,  like  single-entry 
bookkeeping,  uses  the  words  asset  and  liability,  as  well  as  the 
words  loss  and  gain,  from  the  natural  standpoint,  the  stand- 
point of  the  proprietor — no  matter  whether  the  proprietor 
be  an  individual,  a  firm  or  a  corporation.  If  the  reader  is 
in  any  doubt  as  to  the  way  in  which  this  has  been  accom- 
plished let  him  turn  again  to  Chapter  IX  and  observe  how  the 
entries  which  are  made  to  open  the  books  are  there  explained 
without  the  introduction  of  an  intermediate  party.  Let  him 
also  call  to  mind  the  fact  that  a  firm  or  a  company  is  not 
an  intermediate  party  standing  between  its  members  and  the 
outside  world — the  partners  are  the  firm  and  the  stockholders 
are  the  company. 

If  anyone  should  ask  me  how  much  of  the  theory  I  claim 
as  new  and  original,  I  would  say:  All  of  it.  I  claim  that 
this  treatise  presents  the  true  and  complete  explanation  of 
the  art  of  accounting  by  the  double-entry  method ;  and,  more- 
over, I  claim  that  no  other  writer  has  ever  advanced  one 
single  correct  idea  bearing  upon  the  theory  of  double-entry 
bookkeeping — not  one.  That  is  a  broad  claim,  but  I  believe 
that  it  will  stand  the  test  of  the  most  searching  investigation. 
In  the  theory  of  double-entry  bookkeeping,  as  distinguished 
from  single-entry  bookkeeping,  the  whole  problem  and  the 
only  problem  is  to  explain  the  use  of  the  words  debtor  and 

(creditor  in  other  than  personal  accounts ;  and  everything  that 
the  bookkeeper  writes,  everything  that  he  says  and  everything 


DOUBLE-ENTRY    BOOKKEEPING  205 

that  he  does  tends  to  demonstrate  the  fact  that  he  has  never 
taken  a  single  step  toward  the  solution  of  that  problem. 

In  single-entry  bookkeeping  there  is  nothingjg^explainj 
it  is  merely  arithmetic  applied  to  financial  affairs,  the  correct- 
ness of  the  process  is  self-evident;  and,  aside  from  the  figura- 
tive language  which  it  uses,  double-entry  bookkeeping  is 
exactly  the  same  as  single-entry  bookkeeping.  The  only 
problem  in  double-entry  bookkeeping,  then,  is  the  interpreta- 
tion of  its  language,  and  that  problem  the  bookkeeper  has 
never  been  able  to  solve.  He  is  in  the  unique  position  of  a 
man  who  does  not  understand  his  own  language,  and  a  man 
who  does  not  understand  his  own  language  can  never  explain 
anything._/  The  consequence  is  that  in  the  whole  field  of 
human  activity  there  is  not  to  be  found  another  man  who 
is  so  lacking  in  the  ability  to  give  a  reason  for  his  operations 
as  the  bookkeeper  who  uses  the  double-entry  method.  So  far 
as  the  figures  are  concerned  he  knows  that  his  results  are 
correct,  because  the  arithmetic  of  bookkeeping  is  so  simple 
that  there  is  no  possibility  of  going  astray;  but  in  doing  his 
work,  in  recording  a  transaction,  for  example,  he  has  never 
been  able  to  offer  even  the  semblance  of  an  explanation  as  to 
why  he  makes  one  of  the  entries  under  the  heading  "Debtor" 
and  the  other  under  the  heading  "Creditor."  LHe  is  sup- 
posed to  be  engaged  in  mental  as  distinguished  from  manual 
labor,  but  as  a  matter  of  fact  he  cannot  claim  to  be  guided 
by  even  the  faintest  glimmer  of  reason;  his  operations  are 
purely  mechanical.  Instead  of  exercising  his  intelligence, 
he  is  merely  an  imitator,  a  slave  to  custom  and  tradition, 
doing  his  work  in  a  certain  way  simply  because  he  has  been 
taught  to  do  it  in  that  way.J  He  understands  double-entry 
bookkeeping  as  far  as  it  coincides  with  single-entry  book- 
keeping, and  no  further;  aside  from  the  entries  which  he 
makes  in  personal  accounts,  he  cannot  give  a  rational  explana- 
tion of  anything  that  he  does.  •  In  the  case  of  the  simplest 
transaction,  the  case  of  money  paid  out  for  expenses,  for 


206  PRINCIPLES    OF 

example,  if  one  asks  him  whjJie__debitsJExpense  and  credits^ 
Cash,  he  cannot  make  any  reply  at  all,  except  to  say  that  it 
is  always  done  in  that  way.  The  very  form  in  which  he  makes 
his  entries, 

Dr.  Cr. 

Expense    $100 

To  Cash    $100 

proves  that  he  has  no  conception  of  their  true  meaning.  He 
evidently  thinks  that  Expense  is  debtor  to  Cash  and  Cash  is 
creditor  to  Expense,  which  is  an  utter  absurdity. 

If  the  reader  is  inclined  to  regard  the  above  indictment  of 
the  bookkeeper's  intelligence  as  overdrawn,  let  him  examine 
the  text-books  and  see  whether  he  can  find  even  an  attempt  to 
explain  why  we  record  a  disbursement  of  money  for  expenses 
by  debiting  Expense  and  crediting  Cash;  and  if  he  does  find 
anything  of  the  sort,  let  him  compare  it  with  the  true 
explanation,  which  is  as  follows : 

\J)ouble-entry  bookkeeping  uses  figurative  language.  When 
money  is  paid  out  for  expenses,  we  are  supposed  to  borrow 
the  amount  from  the  person  called  Cash  and  to  lend  it  to 
the  person  called  Expense,  therefore  Expense  owes  us  and 
we  owe  Cash ;  we  debit  Expense  and  credit  CashJ 

If  the  reader  will  compare  that  explanation  with  any  that 
he  may  find  in  the  text-books,  he  will  readily  recognize  the 
difference  between  clear  thinking  and  muddled  thinking; 
between  a  logical  statement  and  what  the  lawyers  call  a  non 
sequitur. 

The  writers  who  reject  the  idea  of  personification  beg  the 
question  altogether,  so  far  as  the  real  problem  of  double- 
entry  bookkeeping  is  concerned,  admitting  at  the  very  start 
that,  so  far  as  they  can  see,  the  words  debit  and  credit  have 
no  meaning  whatever  in  other  than  personal  accounts,  except 
as  arbitrary  signs  to  indicate  whether  the  entry  is  to  be  made 
on  the  left-hand  side  or  on  the  right-hand  side.  In  regard 
to  double-entry  bookkeeping  as  distinguished  from  single- 


DOUBLE-ENTRY    BOOKKEEPING  207 

entry  bookkeeping,  these  writers  offer  no  theory  at  all.  Their 
whole  argument  rests  upon  the  mathematical  relations  which 
form  the  basis  of  all  accounting,  which  apply  to  single-entry 
bookkeeping  as  well  as  to  double-entry  bookkeeping,  and 
therefore  cannot  possibly  explain  the  difference  between  the 
two  systems. 

Single-entry  bookkeeping  always  uses  literal  language, 
while  double-entry  bookkeeping  always  uses  figurative  lan- 
guage, except  in  personal  accounts.  That  is  the  difference, 
and  the  only  difference,  between  the  so-called  single-entry 
method  and  the  so-called  double-entry  method.  To  attempt 
to  explain  that  difference  by  discussing  the  equation,  Assets 
-  Liabilities  =  Net  Capital,  is  like  attempting  to  explain 
the  difference  between  prose  and  poetry  by  discussing  the 
origin  of  the  alphabet. 

As  a  matter  of  fact,  there  never  has  been  any  but  the 
one  theory  of  double-entry  bookkeeping  advanced;  and  that 
one  is  false.  There  are  only  two  possible  theories.  The 
accounts  must  be  kept  either  from  the  standpoint  of  the  pro- 
prietor or  from  the  standpoint  of  an  imaginary  agent  of  the 
proprietor;  it  is  impossible  to  conceive  of  any  other  stand- 
point. Of  these  two  theories  the  bookkeeper  has  always 
adopted  the  wrong  one,  the  theory  that  double-entry  book- 
keeping deals  with  the  assets  and  liabilities  of  the  "business," 
and  therefore  assets  and  liabilities  are  always  equal. 

Such  a  theory  is  an  absurdity.  It  not  only  makes  assets 
and  liabilities  equal,  it  makes  them  identical,  thereby 
obliterating  all  of  the  fundamental  distinctions  of  accounting. 
The  amount  under  the  head  of  Accounts  Receivable  is  an 
asset  of  the  business,  because  outside  parties  owe  it  to  the 
business;  but  it  is  also  a  liability  of  the  business,  because 
the  business  owes  it  to  the  proprietor.^  The  amount  under 
the  head  of  Accounts  Payable  is  a  liability  of  the  business, 
because  the  business  owes  it  to  outside  parties;  but  it  is  also 
an  asset  of  the  business,  because  the  proprietor  owes  it  to 


208  PKINCIPLES    OF 

the  business.  i^Tp  base  a  theory  upon  the  idea  that  every  item 
is  both  an  asset  and  a  liability,  because  it  is  asset  of  the  busi- 
ness looking  one  way  and  liability  of  the  business  looking 
the  other  way,  is  like  basing  a  theory  upon  the  idea  that 
every  building  is  on  both  sides  of  the  street,  because  it  is  on 
the  right-hand  side  looking  one  way  and  on  the  left-hand  side 
looking  the  other  way^J  The  text-books  which  teach  such  a 
theory  (and  they  are  the  only  text-books  of  accounting  which 
teach  any  theory  at  all)  are  a  disgrace  to  an  occupation  that 
pretends  to  be  based  upon  reason.  Nowhere  else  in  the  litera- 
ture of  the  arts  and  sciences  is  to  be  found  such  a  jumble  of 
muddled  thinking,  false  reasoning  and  slipshod  logic. 

No  doubt  there  is  plenty  of  room  for  improvement  in  the 
teaching  of  other  branches  of  useful  knowledge,  but  I  know 
of  no  other  the  study  of  which  is  incompatible  with  mental 
honesty ;  while  in  double-entry  bookkeeping,  as  it  is  commonly 
taught,  the  pupil  is  not  even  prepared  to  begin  his  work  until 
he  professes  a  willingness  to  accept  as  true  a  doctrine  which 
he  knows  to  be  false.  I  say  that  he  knows  it  to  be  false, 
because  no  person  of  normal  mind  believes  or  ever  did  believe 
that  assets  and  liabilities  are  always  equal;  and  no  person 
of  normal  mind  is  satisfied  or  ever  was  satisfied  with  a  line 
of  reasoning  which  leads  to  the  conclusion  that  net  asset  is 
a  liability  and  net  liability  an  asset — a  line  of  reasoning  which 
is  a  typical  example  of  what  the  logicians  call  reductio  ad 
absurdum.  To  the  normal  mind  the  argument  which  is 
based  upon  the  idea  of  counting  from  the  standpoint  of  the 
"business"  does  not  prove  that  assets  and  liabilities  are 
always  equal;  on  the  contrary,  the  fact  that  it  leads  to  that 
conclusion  makes  it  a  striking  illustration  of  the  self-evident 
truth  that  to  use  relative  terms  from  a  double  standpoint  is 
to  violate  the  laws  of  rational  speech. 

The  accountant  who  believes,  or  professes  to  believe,  that 
double-entry  bookkeeping  deals  with  the  assets  and  liabilities 
of  the  "business''  never  can  explain  anything  and  never  can 


DOUBLE-ENTRY    BOOKKEEPING  209 

define  anything.  If  we  ask  him  what  net  capital  is,  he  will 
say  that  it  is  the  difference  between  assets  and  liabilities. 
If  we  remind  him  that  assets  and  liabilities  are  always  equal, 
he  will  amend  his  definition  and  say  that  net  capital  is  the 
difference  between  assets  and  actual  liabilities.  If  we  ask 
him  what  he  means  by  the  word  actual,  he  has  no  definition 
to  offer.  If  we  ask  him  to  explain  why  some  accounts  show 
actual  liability  and  others  show  some  other  kind  of  liability, 
he  is  unable  to  explain  it.  If  we  ask  him  what  the  other  kind 
of  liability,  the  kind  which  is  not  actual,  is  called,  he  has  no 
name  for  it.  If  we  suggest  that  what  is  not  actual  must  be 
nominal  or  fictitious  or  imaginary,  he  cannot  admit  the  use 
of  any  of  these  words,  because  he  knows  that  he  may  have 
nominal  or  fictitious  or  imaginary  assets  and  liabilities  among 
his  so-called  actual  assets  and  liabilities. 

What  he  means  by  the  word  actual  is  evident  enough, 
although  he  seems  to  be  unable,  or  unwilling,  to  explain  it. 
LBy___"actual  liability"  he  means  liability  of  the  proprietor./ 
When  he  says  that  an  item  represents  actual  liability,  he 
means  that  it  represents  a  debt  owed  by  the  proprietor.  When 
he  says  that  an  item  represents  liability  but  not  actual  lia- 
bility, he  means  that  it  represents  all  or  part  of  the  net  debt 
owed  to  the  proprietor.  In  other  words,  when  he  says  actual 
liability,  he  means  liability;  when  he  says  liability  but  not 
actual  liability,  he  means  net  asset ;  and  when  he  says  liability, 
he  may  mean  the  one  or  he  may  mean  the  other  or  he  may 
mean  both.  Such  a  use  of  words  precludes  the  possibility  of 
rational  discussion. 

When  the  bookkeeper  says  that  items  like  Capital  Stock 
and  Surplus  represent  liability  but  not  actual  liability,  his 
language  is  on  a  par  with  that  of  the  little  girl  who  says 
that  the  beverage  which  she  is  serving  is  tea,  but  not  "truly" 
tea.  The  difference  between  the  child's  "truly"  tea  and  the 
other  kind  of  tea  is  in  the  fact  that  the  other  kind  is  not 
tea  at  all;  and  the  difference  between  the  bookkeeper's 


210  DOUBLE-ENTRY  BOOKKEEPING 

"actual"  liability  and  the  other  kind  of  liability  is  in  the 
fact  that  the  other  kind  is  not  liability  at  all.  The  use  of 
such  infantile  expressions  brings  bookkeeping  into  contempt; 
it  presents  it  in  the  light  of  a  professedly  rational  pursuit 
that  has  not  outgrown  the  language  of  the  nursery. 

When  accountants  learn  to  use  words  in  their  proper 
sense,  when  they  learn  to  say  asset  when  they  mean  asset, 
liability  when  they  mean  liability,  and  net  capital  when  they 
mean  net  capital,  they  will  be  surprised  to  find  how  much 
higher  a  place  their  occupation  will  hold  in  public  esteem. 


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